Dana Sippel, CFP®, CPA/PFS

Dana Sippel, CFP®, CPA/PFS

When it comes to sailing, it is essential to always make sure all of the lines are secured. They need to be checked, double checked, even triple checked, to ensure a safe voyage. It is this kind of precision and attention to detail that make Dana Sippel not only an exceptional sailor, but has led him to build an experienced career in wealth management.

The 2017 Tax Act improved 529 plans, adding provisions that allow plan balances to be used to pay K-12 tuition.  Prior to 2018, 529 funds could only be used to post-secondary educational expenses.  Here are some new wealth transfer strategies that 529 plans can now fulfill.

Intro to 529 plans

First, a couple of basics about 529 plans. 529 plans come in 2 variations– Prepaid Plans and Savings Plans.  For more details on the differences between these plan types see this article: Best Ways to Save for College.

Although, the Prepaid Plans offer great benefits and can be a good solution for college savings, the Savings Plans open more advanced planning strategies.  This article focuses on planning strategies that mainly apply to the Savings Plans.

There are 3 primary benefits of the 529 Savings Plans:

  • Special Gifting Rules
  • Tax-Free Growth
  • Funds available for a child’s entire educational period and beyond.

Setting up the 529 plans

We recently explored these planning strategies with a retired couple whose goals are to provide an education for their grandchildren and maximize tax efficient gifts to the children/grandchildren.  The use of the 529 plans allows them to take advantage of a special gift rule allowing each person to utilize 5-years of their annual gift exclusion in one year.  In 2018 the annual gift exclusion is $15,000 per person.  By using the 5-year provision, a $15,000 gift becomes $75,000.  As a couple, they can each use this gift election and fund a total of $150,000 to each grandchild’s 529 plan without any tax issues.

This couple’s three grandchildren are quite young, so their 529 plan balances will be available for not only their K-12 tuition, but also later for post-secondary qualified expenses including tuition, room and board, computers, and books and supplies.  The post-secondary expenses can be for vocational training, universities, community colleges or even many international schools.  Qualified educational expenses, the term used for post-secondary expenses, also include advanced degrees.

This couple has wisely chosen to setup the 529 accounts in their own names, for the benefit of each grandchild.  By following this ownership strategy, they have taken advantage of another planning opportunity that removes the 529 account values from their estates but still allows them to retain full control of the asset.

This is an important provision because as the grandchildren mature some may need more funds than others to complete their education.  529 plans have the unique ability to be easily transferred among extended family members with no income, gift or other tax issues.  This allows the grandparents to shift the assets to other family members that may need the funds to complete their educations.  Another benefit of the Grandparents owning the 529 is that it has no initial impact on the child’s potential financial aid, which may have been affected had the parents owned it.

Utilizing the Plan

Carrying this couple’s planning forward five years (assuming the provision is still in place), in the year 2023, they can repeat the 529 funding using the 5-year special gift rule. This will allow them to add another $150,000 to each grandchild’s account.  This couple has also decided to help the parents send each of the grandchildren to private school for their K-12 education.  The couple has the option to use the funds from the 529 plans to pay up to $10,000 per year of primary school tuition or they could use a 2nd special tax provision to pay the private school expenses.  This special tax provision allows the payment of unlimited educational expenses, as long as the payments are made directly to the educational institutional, with no tax implications.

Many states will help this couple with their wealth transfers by allowing 529 plan contributions until the plan balances reach as high as $520,000.  In the Metro DC area, Virginia and DC’s 529 contribution limits are $500,000, while Maryland’s is $350,000.  In selecting a 529 plan, your home state may provide additional tax benefits, although you may choose any state’s plan.  Another noteworthy point is that there are no income limits that apply to persons funding 529 plans.

Any downsides?

Before you jump on board, keep in mind that there may be a few negatives to following this wealth transfer strategy.

First of all, withdrawals from overfunded plans that are not used for qualified educational expenses owe income taxes on the earnings and a 10% penalty.  However, since there is no maximum age for a beneficiary of a 529 plan account, the excess could grow tax-deferred in the account for many years.  And the 10% penalty could be avoided for a number of reasons, including if the beneficiary attends a military academy, receives scholarships, or due to death or disability.

Another thing to keep in mind: 2018 tax changes that allow 529s to be used for K-12 tuition is causing many states to review and consider amending their plans.  Keep an eye on these potential changes and how they may impact planning strategies.