You Can Have Your Funnel Cake On A Stick & Eat It Too!

Can you have your cake and eat it too? When it comes to the magical 529 plan, the answer may be, yes.

MN Nice Investors all know that 529 plans are one of the best ways to help your kids or grandkids pay for the ever-increasing cost of college.But what many don’t know is it can be a great estate planning tool too. This is because the 529 college saving plan is not counted toward the estate of the deceased.

At this point many of you might be saying, “So what”? This is true with most any gift made to the kids or grandkids. People have been reducing their estates by gifting assets for years.

This 529 hack is special because the donor maintains control of the assets! As owner of the 529 account, they can change beneficiaries, investments, and even take a distribution. Of course, the owner is always limited to the investment choices of the 529 plan they are in and distributions may have other consequences. Normally when irrevocable gifts are made to remove assets from the estate, it requires giving up control. I’m not a fan of the IRS, but this makes sense.

The IRS considers the contribution to the 529 plan as a completed gift from the donor to the beneficiary named on the account. In the case of the 529 plan, you can eat your cake without the calories. And as a middle-age man that has to run twice as far to maintain weight, it is a special thing.  

To add a little clarity to the process, each year you are allowed to “gift” $15,000 per year and avoid any gift, or generation-skipping tax, as long as you haven’t made any additional taxable gifts to the beneficiary in that calendar year. This $15,000 “annual exclusion” limit is often considered the max contribution to a 529 plan, per donor, per beneficiary. So, if a father has 4 kids, he can contribute $60,000 total for all four kids per year. A husband and wife can contribute $120,000.

529 plans also have a special 5-year provision where you can accelerate the gifting schedule by electing to make one lump-sum contribution of $75,000 ($15k x 5) ($150,000 per couple) in the first year of a five-year period. Once this is done, the annual exclusion for that beneficiary is used up for five years, which makes sense. If you use the five-year averaging election and die before the five years are up, a pro-rated portion of the contribution will be considered part of the taxable estate.

This $15,000 per year gift-tax exclusion is often cited as the max yearly contribution to a 529 plan. This is not entirely true. If you do go over the yearly amount, not counting the 5-year option, you can elect to have the excess taken out of your lifetime exemption amount. The important distinction here is that you have an annual exclusion amount that is per beneficiary and that resets each year. This is separate from the lifetime exemption amount, of which you only get one. Currently this amount is $11.8 million, and was doubled a couple of years ago. Going over the annual exclusion amount does require the filing of a tax form, so the IRS knows how much is left of your lifetime amount at your death.

With the federal lifetime exemption limit being so large, the average person does not have to worry too much about estate taxes. With Minnesota residences, it is a different story. For 2019, the lifetime exemption amount is at $2.7 million and will increase and top out at $3 million for 2020.While it’s still high, the Minnesota estate tax will impact more families than will the federal.

The average person rarely has to worry about paying gift or estate taxes. However, if you are fortunate enough to have a large estate and want to reduce it during your lifetime to avoid the large federal estate tax, a 529 plan is a fantastic way to do it and still have some control.

It is like me going to Minnesota State Fair, eating anything I want on a stick, and still being able to wear skinny jeans. I can have my deep-fried candy bar on a stick and eat it too.

Two last closing calories. Please consult your financial consultant or tax professional before making any decision and how 529 plans would apply to your own situation. Also, be advised that how 529 plans are viewed may be different for state Medicaid drawdown rules and other situations.