Reap the New Estate Planning Advantages of 529 Plans

If you have young grand- children, take a fresh look at 529 education savings plans. These always were good estate planning tools, but a series of chang- es in recent years make them more attractive ways for grandparents to help grandchildren. You can set up a 529 savings plan account for any beneficiary, and you can set up accounts for as many ben- eficiaries as you want.

You don’t receive a federal income tax deduction for contributions to a 529 savings plan. But 35 states provide a state income tax benefit (either a deduction or a credit) for contributions their residents make to plans sponsored by the state. Six of those states provide income tax benefits for contributions to any 529 plan in the United States.

Contributions receive federal estate and gift tax benefits. A contri- bution qualifies for the annual gift tax exclusion, which is $16,000 per beneficiary for gifts made in 2022. A contribution up to that amount avoids gift taxes and doesn’t reduce your lifetime estate and gift tax ex- emption amount. In addition, in one year you can use up to five years’ worth of annual gift tax exclusions with 529 plan con- tributions.

That means in one year you can contribute up to $80,000 per beneficiary without triggering gift taxes or reducing your lifetime exemption. Of course, you can give smaller amounts without incurring gift taxes. But contributing $80,000 in one year means you’ve used the annual exclusion for that grandchild for the next five years.

The annual gift tax exclusion is per beneficiary, so you can contribute that amount per grandchild without estate or gift taxes. Another benefit is that when the money is in the 529 account, it is excluded from your estate for federal estate tax purposes.

Though the money is out of your es- tate, you still have some control over it. You can decide how the account is invested from among options offered by the 529 plan. You also can change the beneficiary to another family member or even to yourself.

You can withdraw the money from the account if you need it or believe the beneficiary won’t use it. The accumulated income and gains will be taxed and subject to a 10% penalty if you withdraw them. The original contribution won’t be taxed or penalized when withdrawn, but some plans impose a penalty for ear- ly withdrawals of contributions. Investment income and gains earned by the 529 account com- pound tax-free.

Distributions to the beneficiary that are used to pay for qualified education expenses are tax-free, whether the distributions are of your contributions or accumulated invest- ment returns. Among the enhancements to 529 plans in recent years are expansions to the definition of qualified edu- cation expenses. Traditionally, 529 plans were to provide benefits for higher education and often were referred to as college savings plans.

But today they a much broader range of education expenses tax-free. Qualified education expenses in- clude room and board (if the student is at least half-time) and required books and supplies, as well as tuition and most fees. Qualified education expenses also include expenditures for computers and internet costs. Of course, these expenses quali- fy when paid for higher education, including graduate school. But now qualified education expenses include up to $10,000 of annual tuition for kindergarten through 12th grade. The tuition can be paid to a public, private or religious school.

The cost of approved apprentice- ships also can be paid tax-free from a 529 account. The apprenticeship program must be registered with the U.S. Department of Labor. The most recent expansion is that 529 account distributions can be used to pay some student debt.

Up to $10,000 of 529 funds per beneficia- ry can be used to pay student debt. That’s a lifetime limit, not an annual limit. But student debts of siblings of the account beneficiary (including step-siblings) also can be paid tax free.

Up to $10,000 of student debt payments per sibling can be paid tax free from the 529 account. Student debt payments can be of either interest or principal. But if the 529 money is used to pay interest on a student loan, the interest doesn’t qualify for the income tax deduction for student loan interest.

Another important recent change made in a 2021 law is that when a grandparent sets up a 529 account for a grandchild, distributions from the 529 account to the grandchild won’t count at the grandchild’s income and so won’t reduce the amount of financial aid the grand- child is eligible to receive.

More than 90 529 savings plans are offered throughout the United States. Most are sponsored by states or a subdivision of a state. You usu- ally don’t have to be the resident of a state to belong to its plan, and some states openly seek contributions from out-of-state residents by offer- ing quality plans with low expenses and good investment options.

The money in a 529 plan can be spent on qualified education expenses in- curred in any state. Shop around for a plan that’s the best for you. Consider expenses, investment options and how often investments can be changed.