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529 Plans Offer Estate Planning Advantages to Wealthy Investors

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What Does This Article Cover?
  • What are the benefits of Section 529 plans?
  • How do Section 529 plans work?
  • What are the drawbacks of Section 529 plans?
This is the third of a four-part series on college-savings plans.

Section 529 Plans, created as a college savings tool, are becoming increasingly popular among affluent investors because of the tax, estate, and gifting benefits they offer.

Parents and grand parents alike have discovered 529 plans offer three primary benefits, according to a 2003 online presentation by the Financial Planning Association of San Francisco.

  1. The contributions and any future earnings are removed from the donors' gross taxable estate. For some investors this means they can use 529 plans to reduce potential estate taxes by making completed gifts.
  2. The ability to gift large amounts. Anyone can create a 529 plan and make contributions to it. In the vast majority of cases they are created by parents and grandparents who want to help pay for education of their children or grandchildren. 529 plans enable investors to gift large amounts of money on an annual basis.

    The current annual gift limit is $11,000 ( $22,000 for joint filers). Under a special rule, 529 plan investors can contribute five times the annual gift amount all at once — $55,000 per beneficiary ($110,000 for joint filers) and declare the gift over a five year period, without incurring gift tax. This can enable owners to enjoy an immediate estate reduction. If the donor dies during the five-year period, the contributions are counted in his or her estate on a pro-rata basis, according to the number of remaining years, including the year in which the donor dies.

    In deciding when to open a plan and how much to contribute, potential plan owners should consider the potential positive impact it could have on their tax bill and, working with a professional tax advisor, plan accordingly.

    The limit of total contributions allowed in a plan varies by state. Those with a substantial number of children or grandchildren can gift away millions of dollars. There is also no limit to the number of plans an individual or couple can open. States are always updating their plans to make them more attractive, so be sure to check for the latest information.

  3. The account owners retain control of their assets. In many other types of investment accounts if the owner maintains control of the assets the money is considered part of the estate. Under a 529 plan, beneficiary does not have access to the money. Account owners must be of legal age and usually a US citizen or resident alien. Owners can also be the beneficiary of the account. Account owners can also change beneficiaries, as long as it is to another family member, including cousins, step-relatives and in-laws. Owners can even take back the money if they choose, although they will pay federal income tax on the earnings only and possibly a 10% tax penalty. There may also be state and local income taxes and penalties, in addition to any plan penalties.

In addition to estate planning and gift tax benefits, 529 plans offer significant tax benefits for anyone trying to save for a college education.

The money can be withdrawn from the account federal tax free when used for qualified education purposes. The money in the account can also be tax deferred or tax free on a state level as well, depending on the investor's state of residence. State tax treatment will vary. Potential investors may receive better tax benefits from plans sponsored by their own states.

Increasing in Popularity
There is no question 529 plans are growing in popularity and that an increasing percentage of assets is coming from wealthy clients, according to an August 4, 2003 article on financial-planning.com entitled "529 Sponsors Tout Estate Planning Role to Affluent Investors". In that article, one 529 plan director estimates that approximately 20 percent of all the assets in his firm's 529 plans come from high-net worth individuals taking advantage of the estate planning benefits.

According to the College Savings Plan Network, an affiliate of the National Association of State Treasurers, more than 1.5 million accounts have been opened up on behalf of college-bound children as of 2002. Overall, assets in 529 plans more than doubled last year, reaching $18.5 billion, up from $8.5 billion, according to the Investment Company Institute. And by the end of the second quarter of 2003, assets had reached $26 billion, according to the article in financialplanning.com. 1

Joseph F. Hurley, chief executive officer of savingforcollege.com of Pittsford New York, has noted that estate planning is a popular use for 529s and is growing. "Certainly the use of 529 plans as a financial product and a marketing tool for high-net worth individuals has accelerated," Hurley said, in the article in financialplanning.com 2. "The fact is that these accounts can stay open for a very long time and can help generations save for college. There are a lot of wealthy grandparents with lots of grandkids putting hundreds of thousands, if not millions, away in plans," he said.

While some affluent people may be doing it, many more can still take advantage. A recent study by Charles Schwab conducted by Harris Interactive, and cited in the financial planning.com article 3, indicated that many affluent Americans over the age of 45 intend to leave their estate to their children, but very few have a substantial plan to preserve their wealth. In fact, 75% have not made any plans, the survey found.

How 529 Plans Work
The earliest form of 529 plans were prepaid tuition plans that helped to protect against the rise in school costs. These plans were first available in 1980 and are still offered in 20 states. The current, popular Section 529 college savings plans were created in 1996, when Section 529 of the Internal Revenue Code exempted Qualified Tuition Programs (QTP) from federal income tax and allowed states to create these tax-advantaged plans.

QTPs are established and maintained by a state run agency designed to encourage savings for "qualified higher education expenses, which include tuition, room and board, fees, equipment, books and special needs." In establishing a 529 plan in a particular state, account owners are actually purchasing interest in a municipal security. Today every state has a plan in place. Most plans are open to all families in the United States, regardless of state of residency. State tax treatment will vary. Potential investors may receive better tax benefits from plans sponsored by their own state.

Typically the plan's investment options are investment portfolios with underlying mutual funds ranging from offerings of a single fund to multiple funds to multi-fund portfolios. As the competition for investors' dollars has increased so has the number of plans. Some states now have more than one plan; Nevada for example offers five at last count in 2002. In addition, the number of plans managed by professional investment firms has also increased, allowing many plans to offer a number of stock and bond funds that give investors the ability to customize their plans. Asset allocation portfolios, single asset class portfolios and stable value portfolios, for example, are offered by many 529 plans.

Portfolios can be age based whereby as the child approaches college age the asset allocation is more weighted toward fixed income and cash. The money can be withdrawn by the account owner and used by the beneficiary at any eligible college, university, professional or vocational school in America.

The plans became especially attractive when the Economic Growth and Tax Relief Reconciliation Act of 2001 conferred federally tax-exempt status on qualified withdrawals, effective in 2002. Like many of the provisions passed under that Act, there is a sunset clause for 2010 which means that unless Congress acts to either extend the act or remove the sunset provisions the plan's tax treatment will revert to that of 2001(which includes only tax-deferral of earnings, and income tax on withdrawals above basis, at the beneficiary's tax rate).

Drawbacks
There are a few drawbacks to 529 plans. One of them is their relative inflexibility. Account owners can't manage the assets directly. The number of investment options varies from plan to plan and ranges from only a few funds to almost 30. And once the account owner selects the asset allocation, the mix can be change only once per calendar year or upon changing the beneficiary. There are additional drawbacks and risks that should be noted: State tax benefits may be limited to the state's own Section 529 plan. Keep in mind that there are fees and charges associated with a 529 Plan and the underlying investment options are subject to market risk and will fluctuate in value. In addition, 529 plans may not be protected from creditors.

1, 2, 3 - http://www.financial-planning.com, "529 Sponsors Tout Estate Planning Role to Affluent Investors", August 4 2003

If you would like to learn more about 529 plans visit newyorklife.com's Education Center. If you would like to discuss 529 plans in more detail, your local NYLIFE Securities registered representative is available for a no-obligation conversation.

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529 Plans Offer Estate Planning Advantages to Wealthy Investors

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