Not Your Average 529 Plan - Retirement and Estate Planning, Part 2
In Not Your Average 529 Plan – Part 1 we reviewed basic definitions and uses of 529 and 529 ABLE plans for education planning. In Part 2 we are going to discuss non-traditional ways to use 529 plans, specifically for retirement and estate planning.
While 529 plans are commonly used for education savings, they can also be used for tax-efficient estate transfer. This can be done through a process called forward gifting or superfunding. This process takes advantage of a unique provision in Section 529 of the IRS Code that allows people to gift five years' worth of contributions in the present year without incurring a gift tax consequence. If you remember from Part 1, the IRS allows for an annual gift of up to $15,000 per recipient for individuals ($30,000 for married couples) annually without gift-tax consequences (as of 2018).
Let’s break this down in an example for a married couple.
Now – December 31, 2018
Standard gift is made: $15,000 x 2 individuals = $30,000
Anytime in 2019
Forward gift contribution is made: $15,000 x 5 years x 2 individuals = $150,000 (assuming 2018 limits)
2020 – 2023 No gift
By following this method, you’ll have removed $180,000 from your estate by gifting it, tax-free, between 2018 and 2019. You can then continue this process in 2024.
Keep in mind, even though contributions to a 529 plan are revocable (owner can claim their contributions back), plans are treated as completed gifts to the account beneficiary, and the 529 account value is removed from the taxable estate.
Let’s say you maxed out with your pre-tax retirement plan contributions and would like to save more for your retirement. Your income doesn’t allow you to make a deductible IRA contribution or a contribution to a Roth. What else can you do? Open up a 529 plan with you listed as the owner and beneficiary.
Yes, you can be both the owner and beneficiary of a 529 plan, and here’s why you should.
1. Your contribution gets you a state tax deduction or credit depending on your state rules. In Pennsylvania, it’s a deduction up to $15,000 (that gift tax limit again).
2. Your account grows tax-deferred with compounding returns as long as you keep money in the account.
3. When you withdrawal the money in retirement, you will incur a tax (just like it would from the retirement account) and 10% penalty because the money is not being used toward qualified education expenses. BUT your income tax bracket will potentially be lower since you’re no longer receiving income
from employment. You will also only pay the tax and penalty on the earnings portion, not on what you put in.
o Note that each withdrawal from the 529 plan contains a pro-rata portion of earnings and principal. You cannot just take out the principal and avoid the tax and penalty.
Education Legacy Planning
What happens if there is still money in a 529 after the beneficiary has completed their education? You can use these funds for future generations.
You can move the beneficiary up or down the family tree, naming the beneficiary’s child, parent, or even yourself as the replacement beneficiary. Account beneficiaries can be changed as many times as you want and not create any tax implications with that process. This means that any excess funds in your 529 plan can remain there to be passed down from generation to generation in your family (unless your 529 plan has a restriction).
Stay tuned for: Social Security: Less known but important claiming considerations to maximize your income in retirement.
Marianna Goldenberg, CDFA® is a financial consultant with CURO Wealth Management at 1705 Newtown - Langhorne Road Suite 5, Langhorne, PA 19047. She offers securities as a registered representative of Commonwealth Financial Network®, Member FINRA/SIPC. A registered Investment Adviser. She can be reached at 215.486-8350 or at firstname.lastname@example.org.
The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.