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529s: Estate-tax bonus
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December 12, 2000: 6:10 a.m. ET
Make big tuition-plan contributions while also reducing your taxable estate
By Staff Writer Jeanne Sahadi
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NEW YORK (CNNfn) - State-qualified tuition plans – or 529s as they are commonly known – offer contributors and beneficiaries many tax advantages, but there is one that may not be readily apparent when you're busy saving for your child's or grandchild's education: They can offer a tremendous boon to your estate plan.
"It can take a large amount out of your taxable estate," said Brian Orol, a certified financial planner (CFP) based in Raleigh, N.C.
Read CNNfn.com's primer on 529 plans
That's because money you contribute to a 529 plan is no longer considered part of your estate, and there are ways to put in far more than the $10,000 annually without incurring the gift tax.
In fact, as a married couple "you may remove up to $100,000 (from your estate) in one fell swoop," said CFP Judy C. Miller, who runs College Solutions in Alameda, Calif. And that number can climb even higher if you are setting up more than one 529 plan, assuming each plan has a different beneficiary.
Crunching the numbers
Here's how it works. As an individual, you may contribute up to $50,000 at one time to a 529 account and then treat that contribution as if it were being made in $10,000 installments over the next five years, hence making it free from gift tax.
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(As a married couple) you may remove up to $100,000 (from your estate) in one fell swoop.
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Judy C. Miller
Certified financial planner |
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Under the same principle, your spouse can contribute another $50,000 to the same account, for a total of $100,000 in contributions in one year. Allowed to grow tax-deferred, the entire $100,000 would no longer be considered part of your estate, unless you or your spouse dies before the fifth year, in which case some portion of it would be.
So, say you and your spouse are grandparents with a $1.5 million estate and a few grandchildren. The first $675,000 of your estate will be exempt from estate tax and you can shelter a sizeable portion of the remaining $825,000 through contributions to 529 plans for the grandkids, Orol said.
If you die soon after making a contribution
If you make a $50,000 contribution to a 529 plan but die before the five-year, gift-tax-protected period is up, the money can stay invested in the plan but it will be treated as a part of your estate on a pro-rated basis. "If you die, yes, the money comes back, but less comes back," Orol said.
In other words, the total amount minus $10,000 for every year you were alive during the five-year period is considered part of your estate. So if you make a contribution in February 2001 and die two months later, $40,000 would be subject to estate tax and $10,000 would be treated as your gift to the beneficiary that year.
Control, flexibility a plus
One of the big advantages to the 529 plan, experts say, is that control of the account always remains with you, the contributor. As the owner of the account, you can access that money any time you need to, Miller said. Of course, if you draw on the money for your own purposes, you will pay a 10 percent penalty plus income tax on the appreciation, she noted.
Another plus as owner: You may change the beneficiary at any time. So, for example, if your grandson never uses the money for college but then has a child of his own, you may name your great-grandchild as the new beneficiary and let the money continue to grow tax-deferred for another 20 years.
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 WHEN SETTING UP A 529, DON'T FORGET:
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Beneficiary must use money for educational purposes.
When money is withdrawn for education, it will be taxed at the student's tax rate.
If beneficiary or account owner withdraws for non-educational purposes, he or she will pay a 10% penalty plus income tax at the owner's rate on appreciation in the account.
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The only restriction is that the new beneficiary must be a relative of the original beneficiary. So if you put money aside for a close friend's daughter, and she didn't use the money, you can name her child as beneficiary, but not your own niece or nephew.
And in many states' plans, there is no age limit on the beneficiary, so conceivably you can name your adult child as a recipient of the money. But there may be a regulation that requires your son or daughter to use the money within 10 years, said CFP Gerald R. Weiss, a 529 adviser in Dublin, Calif.
All told, experts say, the 529 offers a number of tax and estate benefits that are worth looking into. "It's a very powerful tool. There's a lot of flexibility," Orol said. 
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