Everyone with a child has probably enjoyed Dr. Seuss’ Oh, the Places You’ll Go!, a short children’s book emphasizing each person’s potential for success and personal development in life, limited only by one’s imagination. While as a child the story can be quite inspiring, most people will not realize this potential without a proper education, and nowadays this means college. Praises to Dr. Seuss for inspiring so many, but he did fail to mention that such potential could be further stifled by the ever-increasing cost of education. Luckily, with proper planning and recent changes in the law, you can be better equipped to assist your child in achieving the potential Dr. Seuss so describes.
A common topic in estate-planning discussions involves tax-advantaged options for endowing successive generations with the ability to afford the rising costs of higher education. Luckily, several strategies exist including direct payment of tuition (elementary to graduate school) or a 2503(c) minors trust, and 529 Plans. Each educational strategy has its limitations, but the 529 Plan (named after the section of the Internal Revenue Code from which it originates) offers a popular educational savings vehicle that provides flexibility, control and tax savings.
Anyone can create and contribute to a 529 Plan and each state offers its own version. The differences by state include the investment advisor, fees charged, investment options, and availability of state income tax deductions for amounts contributed. Despite each state having its own version of the 529 Plan, generally the plans are not exclusive to the state of the plan’s origin and may be used interstate; however, depending on the type of plan chosen additional restrictions may apply.
Operationally, a 529 Plan functions similarly to a traditional individual retirement account. Like an individual retirement account, a 529 Plan enjoys tax-free growth while the funds remain in such account. Distributions from a 529 Plan will not be taxed so long as they are made solely for “qualified higher education expenses.” Distributions made that do not qualify as “qualified higher education expenses,” will become subject to federal taxes and a 10% penalty.
Traditionally, the term “qualified higher education expenses” pertained only to expenses for matriculation and living expenses associated with post-secondary institutions of higher learning (public and private). Examples of expenses covered include: tuition, fees, room and board, and purchase of a personal computer and peripheral equipment if required by the institution. The Tax Cuts and Jobs Act of 2017 (Act) expanded the scope of “qualified higher education expenses” to include “expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school,” but uncertainty exists as to whether this benefit will be available in Michigan due to possible constitutional issues.
While the Act does serve to expand the scope of expenses covered, it also caps the amount of expenses payable to elementary and secondary schools at $10,000 per year. Expenses for post-secondary institutions remain uncapped by a specific dollar amount, but are limited to the posted tuition, fee and room and board schedule published each year by the post-secondary institution the student is attending.
One popular feature of the 529 Plan is the ability to fund the plan upfront with 5 years’ worth of annual exclusion gifts. For 2018, the annual gift tax exclusion amount is $15,000 per person. This translates into the ability of an individual contributor to “front-load” a 529 Plan with up to $75,000, or $150,000 if married and an election to split-gifts is made. It should also be noted that 529 Plans do have a maximum contribution cap, which varies by state (generally $235,000 to $520,000).
Another popular feature of the 529 Plan is the ability to change the plan’s beneficiary if funds remain; however, this change is limited to certain family members of the primary beneficiary.
Finally, careful consideration should be undertaken as to who will be the owner of the 529 Plan as unintended transfer tax consequences can occur if not first discussed with your estate planner.
529 Plans offer flexibility and opportunity. If you have questions or are interested in a 529 Plan or other strategies to assist successor generations “move mountains,” contact your estate planner.