529 plans are not only a great estate-planning tool way to save for your children or grandchildren’s’ college tuition, but they have another added bonus too. Under a tax-law exception this year, clients can make a lump-sum 2021 gift of up to $75,000 to fund a 529 college savings account for a child or grandchild (or any other college-bound individual) and claim a federal gift tax exclusion for the full amount. Wealthy donors can use this tactic to sizably reduce an estate without using any of their lifetime exemption if they meet some conditions.
This accounts for five years’ worth of the standard $15,000 annual exclusion that normally applies to 2021 gifts. If you make a five-year gift of $150,000 per couple, for example, and report it on your gift tax return, it uses zero of your exemption. We have found that many people are not aware of the tax break and how they can take advantage of the tax-free growth.
Income earned in and qualified distributions from a 529 are generally not taxed except under some states’ special rules. Non-qualified distributions are taxed and subject to a 10% penalty.
The Tax Cuts and Jobs Act of 2017 also allowed for 529 money to be used for tuition for grades K-12, which is a potentially quicker accumulation of assets, and useful for those who decide to send their children to private school.
There are conditions to be wary of in the current political climate. If a donor funds a plan with $75,000 for the benefit of an individual, for example, that donor could not give that individual any additional gifts over the five years without dipping into their lifetime exemption, which is currently $11.7 million per person. Also, there is another caveat to be aware about, that if the donor dies within the five years, the balance goes back to the deceased donor’s estate.
It’s important to note that grandparents are a very great user of this program, as it removes assets from taxable estates in large sums and the money is invested to grow and earn income tax-free. If you are currently contributing to a 529 plan or are considering opening one, we are happy to discuss your situation and more of the benefits involved. If you have any questions or would like to discuss these plans, please feel free to contact us at info@shermanwealth.com or schedule a 30-minute complimentary meeting here.