You have probably heard of so-called "529 plans," even if you haven't looked into getting one. If you have children or grandchildren whose education is important to you, though, you may want to investigate 529 plans to help ensure that when the time comes, your loved ones don't have to turn down their dream school because they don't have the funds to pay for it. Let's talk about some of the benefits of 529 plans.
Simply put, a 529 plan is an account used to save for educational expenses. These plans were named for Section 529 of the Internal Revenue Code. This section was added to the Code in 1996, and confers tax-free status on "qualified tuition programs." The first 529 plan to be established was a prepaid tuition plan created by the Michigan Education Trust.
Prepaid tuition plans are one of two types of 529 plans. The other is an investment savings plan. Many states sponsor their own 529 investment plans, but you may not need to be a resident of a particular state in order to participate in that state's plan. However, your state may offer you a state income tax benefit for participating in their plan. Investment savings 529 plans have become more common than the prepaid tuition plans.
Contributions to 529 plans are not tax deductible on a federal level (individual states may make contributions tax deductible up to a certain amount). That doesn't mean there is no federal tax advantage, however. Income earned from investments in a 529 plan account is not taxed while in the account. So long as the money, when withdrawn from the account, is used for qualified education expenses, distributions are tax free. Put another way, earnings on investments in the account are never taxed if used for a qualifying purpose. That's right: your child or grandchild (or other designated beneficiary) can pay for educational expenses using money you earned tax-free.
So what are qualified education benefits? They include college tuition as well as tuition for an elementary or secondary private, public, or religious school. Other qualified education benefits include:
Note that some of these changes are new in 2018; originally, 529 plans were intended to be used only for post-secondary educational expenses. However, it is now possible to use up to $10,000 of distributions each year for K-12 expenses.
You may be surprised to learn that planning for your child or grandchild's education can have benefits for your own estate planning. You can use a 529 plan to remove assets from your own taxable estate—yet you can still exercise control over those assets. Typically, when you retain control of an asset, it remains part of your taxable estate. 529 plans, due to their structure and authorization by statute, are different.
Contributions you make to a 529 plan may qualify for the annual gift tax exclusion; you can give up to $15,000 per year to each recipient without incurring gift tax liability or the need to file a gift tax return.
In addition, contributions you make to a 529 plan may qualify for the annual gift tax exclusion; you can give up to $15,000 per year to each recipient without incurring gift tax liability or the need to file a gift tax return. What's more, you may contribute up to five years' worth of exclusions at one time. So long as you survive into the fifth year, the contributions you have made to the 529 plan will not consume any of your combined gift and estate tax exclusion. In other words, your contributions to the plan will have been made entirely free of gift tax.
Contributing to a 529 plan for the benefit of children and grandchildren has another estate planning advantage, as well. If you value education, using a 529 plan is a way to guide your loved ones toward the future you would wish for them, and to make an education that might otherwise have been too costly possible.
Though 529 plans are most commonly created for the benefit of children or grandchildren, in fact, anyone can create a 529 plan for anyone else; no familial relationship is required. Furthermore, contributions can be made up to a high total limit. In Michigan in 2018, you can contribute up to a total of $500,000 to a 529 plan. Changing beneficiaries is relatively straightforward, so if, say, your eldest grandchild doesn't use up all the funds in the account that you had designated for him or her, you can make your younger grandchild the beneficiary of those funds.
While 529 plans are a useful way to set aside assets for your loved ones' educations, there are other choices as well. If you are interested in planning for a child's or grandchild's education, we invite you to contact our law office to discuss the options that are right for you and your family.
If you do decide to make use of a 529 plan, you must be sure to name a successor owner for your account. Otherwise, the account will be subject to probate, an undesirable outcome that you can easily avoid with a little advance planning. Typically, people choose to list a spouse as primary successor owner; if you have a revocable trust, you may choose to make the trust a back-up successor. If you are able to name only one successor, the trust is a good choice in order to ensure the account will not need to go through probate.
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