Lifetime gifting to children and grandchildren is an important estate planning tool that can result in substantial estate tax savings. For that reason, we often recommend it to wealthy clients. Typically, for gifted assets to be excluded from a donor’s estate at death and not subject to estate taxes, the gift must be complete and irrevocable. That means that once a gift is made the donor cannot access or control the gifted assets. Even clients with substantial assets may be reluctant to make gifts because of this loss of access and control.
But there is one type of gift that allows donors to make lifetime gifts that will be excluded from their estates without losing access or control – gifts to Section 529 plans. 529 plans are tax-advantaged investment accounts in which a donor sets aside money to fund a child or grandchild’s college education. Contributions to a 529 plan of which the donor is the owner (sometimes called the “participant”) are not included in the donor’s estate and will not be subject to estate taxes. Yet, importantly, the donor, as the account owner, retains control over the assets. In addition, the donor can reacquire the assets in the future (provided he pay income taxes and a penalty). Because the donor retains access and control, gifts to 529s allow the donor to “have his cake and eat it too.”
There are some disadvantages to consider. Distributions from 529 plans must be used on qualified higher education expenses and if not, are subject to penalty. Assets in a 529 account may impact the student’s eligibility for financial aid. For more on that, see my prior post. Also, there is one exception to the estate exclusionary rule. A donor may frontload a 529 account with five times the annual gift tax exclusion amount (currently $14,000), for total gifts of $70,000 per donor, but if he dies within five years following the contribution, a portion of the gift will be included in his estate and subject to estate tax.
For clients interested in reducing estate taxes but reluctant to lose access to and control of assets, lifetime gifts to 529 plans may be an appealing way of making lifetime gifts. In addition, for emotional reasons, the opportunity to fund a grandchild’s college education may be especially meaningful. 529 accounts are also easy and inexpensive to set up and administer, and for those reasons can be a great way to make gifts.
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