529 Essentials: 529s and Intergenerational Wealth Planning

Based on recent studies, ultra high net worth individuals across the globe are expected to transfer approximately $4 trillion between generations over the next decade. Quantitative and qualitative research also suggests that roughly 90% of beneficiaries will change financial advisers when the assets are received upon death of the account owner. Therefore you as an adviser, accountant or estate planner can gain a client through client retention when the assets do matriculate. Ideally, the retention can be earned through building a relationship with the next generation by helping the children and grandchildren efficiently save and pay for college. Secondly, advisers have an opportunity to build a relationship with the next generation by helping the children and grandchildren through the creation and execution of a budget to management the student loan debt repayment process. For either tactic, college financial planning can help you grow and protect your book of business, and this article explains one path on how to achieve this goal.

Market Sizing: Grandparents are the accountowners of 18.3% of 529 accounts as of 2016 based on data by Strategic Insight. Additionally, there were 12.9 million accounts as of the second quarter of 2016 based on data by Strategic Insight, with 11.8 million in 529 savings plans and 1.1 million in 529 prepaid plans. Therefore, grandparents are the accountowner of approximately 2.4 million 529 accounts as of the second quarter of 2016 and this number and percentage of accounts are projected to grow.

Considerations for Grandparent Owned 529 plans

—Legacy Planning: 529s help families earmark savings specifically for college in a tax, financial aid and estate planning efficient manner. Although there are exceptions, the 10% penalty rule on non-qualified distributions helps to ensure the legacy of education and the importance of education lives on from one generation to the next. Therefore, 529s provide an important value add to clients seeking to build a legacy on the importance of education.

—Portability: A part of this intergenerational wealth planning functionality is that the accountholder gets to maintain control of the account, and can change the ownership of the account from one grandchild to another family member at any time. The definition of a family member from a 529 plan perspective includes grandparents, parents, siblings, children, first cousins and others as noted in IRS Publication 970. Therefore while 529 plan assets are revocable, the grandparent gives up control of the account with most types of trust accounts and are therefore termed irrevocable. Also as a quick reminder, unlimited changes in beneficiary to another family member of the previous beneficiary is significant as accountowners are allowed two investment changes per calendar year for the same beneficiary within the same 529 plan and one change in 529 plan for the same beneficiary per twelve month period.

—Removal from the Estate: Another benefit is that assets are removed from a contributor’s taxable estate, as contributions into a 529 plan are considered a gift. There are two exceptions to this. The first exception is when 529 accountowners name themselves as the beneficiary. Second, there is a five year throwback provision for some 529 plans if the contributor passes away in less than five years during a five-year gifting period. In this scenario, contributions for any of outstanding time remaining would be pulled back into the estate.

—Front-Loading of College Savings: As a reminder from a prior 529 Insiders article, in order to accelerate the estate planning benefit of 529s, the annual contribution limit is $14,000 as of 2016, or the accountowner can make a five year gift in one year up to $70,000 individually or $140,000 per couple to each child’s 529 plan without triggering federal gift-tax consequences. While this is a significant amount of assets, no other gifts are allowed to be made to the same beneficiary during five-years as the maximum amount of $14,000 per year has already been met. For the five-year election, contributions must be more than $14,000 and less than $70,000 per individual as of 2016, and the contributions must be equally pro-rated over a five year period. In order to go from $70,000 per individual to $140,000 per couple, spouses must file separate elections. Also, concurrent elections are allowed so long as the net value of all gifting in a year (including applicable prior pro-rated amounts applied to the year) do not exceed $14,000 as of 2016.

—Financial Aid: While 0% of income and assets are included in the FAFSA calculation for grandparent owned 529 assets, distributions from the grandparent owned 529 accounts for college expenses may be considered student income and must be reported on the financial aid forms. Such income can reduce the amount of aid by up to 50% of the amount of the distribution. In order to mitigate this issue, distributions from the account can take place in the later years of college. For example, distributions during the beneficiary’s junior or senior year for a four year undergraduate degree will not impact FAFSA calculations due to the prior-prior timing of asset and income reporting for FAFSA calculations. Therefore in this example, income earned through 529 distributions from a grandparent owned 529 plan in a student’s junior or senior year will not impact the financial aid packages for that undergraduate degree due to the timing of the income. Despite the potential issue, grandparent owned 529 plans are still a better alternative to 2503(e), which is when the direct payment of tuition by a grandparent does not count as a gift. Two important components of 2503(e) is that it can only be used for tuition, and there is mortality risk in solely using this strategy. Therefore some suggest the use of 529 savings plans and 2503(e) together.

—Medicaid: Lastly, if the grandparent that owns the 529 plan applies for Medicaid, the state will require use of the 529 assets to pay for medical expenses.

Therefore, advisors, accountants and estate planners should understand the key components of integrating college financial planning and intergenerational wealth planning. In doing so, you will help your clients, and in turn, grow and retain your book of business. Have the college financial planning discussion with your clients today.