For the most part, grantors are required to give up all control of gifted assets. This has many people so afraid of estate tax inclusion that they are completely repelled from this option, but the 529 plan provides the single exception to the rule. Section 529 of the IRC states that no amount can be included in someone’s gross estate for estate tax purposes if it’s used in the interest of a qualified tuition program.
Why Choose a 529 Plan Over an Irrevocable Trust?
When you make lifetime gifts to an irrevocable trust, it offers a way to lower your federal and state estate taxes. It is among the most commonplace methods for achieving this end. But if you want that irrevocable trust to remain free from taxes once the grantor has passed away, it has to keep the same beneficiaries.
This rule feels limiting to some. You may find yourself backed into a corner in the event that your situation changes, and the inability to alter the trust’s beneficiaries may become problematic.
For example, a grantor may create a trust for their child. But once the child grows up, they may no longer require the money. In some cases, the grantor might end up in need of the money for their own use.
It’s still possible to make an irrevocable trust somewhat more flexible if they grant powers of appointment to these beneficiaries. They might also appoint a trust protector. However, it’s not always the case that the grantor has the power to take either of these actions. It’s this lack of control that deters many people from setting up irrevocable trusts when they talk to their estate planning lawyer.
It’s important to consider the exceptions to the 529 rule. For one thing, there’s a good chance that your 529 plan can be included in a beneficiary’s estate once that beneficiary has passed away.
The point of a 529 plan is to help with the costs associated with education. As such, it can’t be used to completely replace an irrevocable trust.
Front Loading Your Annual Exclusion Gifts
Oftentimes, grantors will engage in a practice known as “front loading.” This is when you bump up your annual exclusion gifts so they happen earlier, which is part of what makes 529 plans such a potentially advantageous option. The annual exclusion from gift tax currently lets grantors transfer as much as $17,000 per individual annually.
With strategic use of the gift tax return, grantors can put all of their annual exclusion gifts for the next five years into one year without the use of any transfer tax exemption. Additionally, grantors who are married can elect to do gift-splitting, through which the couple is currently able to transfer up to $170,000 in one year to their 529 plan. This comes with no estate or gift tax exemption.
Bear in mind, though, that if five years of the annual exclusion gifts are front-loaded and the grantor passes away before the end of that period, some of the amount that was gifted can be included in the estate of the grantor. In spite of these possible catches, a 529 plan is an option that offers more flexibility than virtually any other for your estate tax plan.
Grantors Can Change Beneficiaries and Move Assets
Through this method, grantors have the ability to own a 529 plan and keep their power to make changes to their beneficiaries. This means you can change it to a family member who qualifies. These include nieces, nephews and grandchildren, among others.
At the same time, you can remove any asset in the plan from your estate. This is different from how an irrevocable trust works. With irrevocable trusts, grantors are unable to act as trustees. They also don’t have the power to alter their beneficiaries.
It should be noted that any distribution that the earning portion of non-qualified distributions is still subject to standard income tax, which comes at the beneficiary’s tax rate. In addition, a 10% penalty is added to this. Non-qualified distributions include any that aren’t used for qualified higher education costs. That’s why it’s highly advisable not to overload your 529 plan with funds.
If used strategically, a 529 plan may serve as a powerful wealth transfer vehicle. And for many grantors, it’s highly likely that there’s someone in their family who they’ll want to significantly contribute to their education at some point.
If you are interested in how a 529 works or have estate planning questions, call the Knee Law Firm at 201-996-1200. We’ll connect you with a knowledgeable estate planning lawyer from our office in Hackensack, New Jersey.