.jpg)
Understanding 529 Plans: A Key Component in Your Estate Planning Strategy
- Chad A. Ritchie, Esq.
- 2 days ago
- 5 min read
What Is a 529 Plan?
A 529 plan is a tax-advantaged investment account designed to encourage saving for future education expenses. Named after Se
ction 529 of the Internal Revenue Code, these plans offer significant tax benefits when funds are used for qualified educational costs, including tuition, fees, books, and room and board for college, as well as certain K–12 expenses.
Types of 529 Plans
There are two primary types of 529 plans:
College Savings Plans: These function similarly to investment accounts, allowing you to contribute after-tax dollars into various investment options, such as mutual funds or exchange-traded funds (ETFs). The account’s value can grow over time based on the performance of these investments. Withdrawals for qualified education expenses are tax-free.
Prepaid Tuition Plans: These plans allow you to prepay tuition at current rates for future attendance at specific colleges or universities, effectively locking in today’s tuition costs. However, they often have residency requirements and may limit the beneficiary’s choice of institutions.
Finding the Right 529 Plan
Each state offers its own 529 plan, but you are not limited to investing in your home state’s program. It’s essential to compare plans across different states to find the one that best suits your needs. Consider factors such as investment options, fees, and state tax benefits. Some states offer tax deductions or credits for contributions to their 529 plans, which can enhance your savings strategy.
Business insider ranked Illinois' 529 plan as the #1 529 plan of all states.
For a helpful comparison, check out SavingForCollege.com, which provides rankings and detailed reviews of each state’s plan.
529 Plans in Estate Planning
Incorporating a 529 plan into your estate plan can provide substantial benefits:
Reduction of Taxable Estate: Contributions to a 529 plan are considered completed gifts to the beneficiary, meaning they are removed from your taxable estate. This can help in reducing potential estate tax liabilities.
Control Over Assets: As the account owner, you retain control over the funds, including the ability to change beneficiaries or withdraw assets if necessary (though non-qualified withdrawals may incur taxes and penalties).
Accelerated Gifting: 529 plans offer a unique gifting feature that allows you to make a lump-sum contribution of up to five times the annual gift tax exclusion amount in a single year and elect to treat it as if it were made over a five-year period. This means you can contribute up to $90,000 per beneficiary ($180,000 for married couples) without incurring gift taxes, provided no other gifts are made to the same beneficiary during that five-year period.
Is a 529 Plan Still Included in the Donor’s Estate?
One of the most attractive estate planning benefits of a 529 plan is that the contributed funds are removed from your taxable estate while you still retain control over the account. However, there are a few key considerations:
Annual Gift Tax Exclusion and Estate Removal:
When you contribute to a 529 plan, the gift is considered a completed gift for tax purposes, meaning it is no longer part of your estate.
If you take advantage of the five-year accelerated gifting strategy, the amount you contribute is also removed from your estate—as long as you live beyond the five-year period.
What Happens If the Donor Passes Away?
If you contribute using the five-year acceleration method and pass away before the five years have elapsed, the portion of the gift that has not yet been recognized (i.e., the remaining portion of the five-year spread) will be added back to your taxable estate.
Any contributions made outside the five-year acceleration are permanently excluded from your estate.
If the Funds Are Withdrawn by the Donor:
If you withdraw the funds for a non-educational purpose before passing away, the money may once again become part of your estate and be subject to estate taxes.
Pro-Tip: Use the Five-Year Gifting Rule Wisely – If you have a large estate and want to reduce future estate taxes, consider front-loading your 529 contributions while ensuring you outlive the five-year period.
Naming Beneficiaries and Successor Custodians
Who Is the Beneficiary of a 529 Plan?
The beneficiary of a 529 plan is the person who will use the funds for education expenses.
The account owner (donor) can name anyone as a beneficiary, including children, grandchildren, relatives, or even themselves if they plan to return to school.
If the original beneficiary does not need the funds, the account owner can change the beneficiary to another qualified family member without penalty.
Does the Donor Become the Custodian of the 529 Funds?
The donor (account owner) does not technically act as a custodian of the funds but does retain control over how and when the funds are distributed.
Unlike custodial accounts (e.g., UTMA/UGMA accounts), where funds belong to the child at a certain age, the donor in a 529 plan maintains ownership and can decide to reassign the funds, withdraw them, or name a new beneficiary if needed.
Naming a Successor Custodian
Since the donor maintains control of the account, it’s crucial to name a successor custodian in the event of the donor’s passing or incapacitation.
A successor custodian is the individual who will take over management of the 529 plan should the original owner pass away.
If no successor is named, the plan may be subject to probate or default to the donor’s estate, potentially losing tax advantages.
Many 529 plans allow you to designate a successor custodian when opening the account or updating account document.
Pro-Tip: Always Name a Successor – Failing to name a successor could lead to unnecessary complications, including delays in accessing funds or estate tax implications. Ensure this step is included in your estate plan.
Conclusion
A 529 plan is a versatile tool that not only aids in funding education expenses but also serves as an effective component of a comprehensive estate plan. By leveraging the tax advantages and flexibility of 529 plans, you can support your loved ones' educational goals while strategically managing your estate.
For more detailed information on 529 plans and their role in estate planning, consider reading the following articles:
529 Plan: What It Is, How It Works, Pros and Cons
This article is a service of Attorney Chad A. Ritchie and the Ritchie Law Office, Ltd.
Click Here or call (309) 662-7000 to learn more about Ritchie Law Office, Ltd. and our Estate Planning process, which starts with an initial consultation called our “Ritchie Legacy Planning Session”.
To sign up for the Ritchie Law Office, Ltd. monthly newsletter, click here! Keep up with estate planning news, federal and state legislation affecting your estate plans, and the latest events and happenings at Ritchie Law Office, Ltd.