Extremely wealthy clients may see the current stock and real estate markets as a great estate-planning opportunity to transfer depressed assets to their heirs, but most retirees are likelier to be torn between a desire to help their financially stressed children and anxiety about meeting their own long-term expenses.
For the latter folks with battered portfolios, 529 college savings plans for grandchildren are the Christmas and Hannukah gifts of choice: An Internal Revenue Code Section 529 account reduces the donor's estate, but he can retain ownership of the account and therefore the right to ask for the money back at any time.
"It's a way to remove assets from your estate without removing your ability to control those assets," said Joseph Hurley, a Pittsford, N.Y.-based tax accountant who is the founder and chief executive of savingforcollege.com LLC. No other vehicle affords this unique combination of control and estate reduction. A 529 account is always controlled by its owner, not its beneficiary, in contrast to asset transfers to trusts, family partnerships and custodial accounts under the Unified Gifts to Minor Act and Uniform Transfers to Minors Act, which are all irrevocable gifts.
Under Internal Revenue Code rules for a Section 529 account, "the account owner can change the beneficiary. He can even name a successor owner," said Alan E. Weiner, a certified public account and tax attorney who is a senior tax partner at Holtz Rubinstein Reminick in Melville, N.Y.
Savingforcollege.com is a division of BankRate Inc., a financial research firm and aggregator of rates, and Mr. Hurley is a vice president at the web-based firm, which is located in North Palm Beach, Florida.
Maximizing the gift
Unlike other college savings vehicles, 529 plans have no income eligibility requirements or maximum annual contributions, although plans can limit total contributions per beneficiary over the lifetime of an account. What’s more, one can make accelerated lump-sum 529 contributions equal to five years of annual gift exclusions.
"With the 5-year election, a grandparent can gift up to $60,000 to each grandchild in 2008 without triggering a gift tax," Mr. Weiner said. "If both grandparents are alive, it can be as much as $120,000." If the donor cancels the 529 account or dies during those five years, amounts above the annual gift tax exclusion are included in his estate. "If you make a five-year gift and die in the third year, for example, the remaining two years' worth is pulled back into your estate," Mr. Weiner said.
A 529 account must be funded with cash. "But today if you sell an investment to fund a 529, you pay a historically low capital gains tax rate," noted Kalman A. Chany, president of Campus Consultants Inc, a New York financial aid consulting firm, and author of “Paying for College without Going Broke” (The Princeton Review, 2008).
"In fact, this may be an ideal time to do it," he added, "because you can buy stock cheaply in the account when the grandkids are young, and all the appreciation when the market recovers will be tax-deferred."
Indeed, the earnings will be tax-free if the account distributions are used to pay for higher education. If not, they're subject to ordinary income taxes and a 10% penalty. The taxes and penalty only apply to any increase over the original investment, not to the entire distribution, Mr. Chany said.
Five-year gifts vs. annual gifts
The drawback to using the five-year election is that you can’t make tax-free gifts to the same recipient during the next five years. For that reason, many people prefer to make annual gifts, Mr. Weiner said.
Gifts are driven by emotion, not tax rules. "From a tax viewpoint, it's better to make a gift in January rather than at Christmas or Hannukah," he said. "If you die later in the year, you haven't lost that annual gift tax exclusion. But people say, 'There's nothing special in January. I want to give at the holidays, when the children expect it.'"
Clients who make substantial 529 gifts to grandchildren should remember the federal generation-skipping transfer tax, Mr. Weiner said. The GSTT applies to transfers made during your life and at your death to someone more than one generation below you; it’s levied in addition to, not instead of, federal gift and estate taxes. The current GSTT exemption is $2 million.
The fine print
A 529 account owned by a grandparent doesn't have to be reported as an asset on the federal application for financial aid to college. "But distributions taken from that account on behalf of the student must be reported on the application as income to the student,” Mr. Chany said. “They could reduce his or her financial aid by 50 cents on the dollar." By contrast, an account owned by a student or a student's parent must be listed as an asset on 2009/2010 federal aid applications; but distributions aren't considered income.
As for Medicaid planning, state Medicaid agencies treat a 529 account as an asset available to pay for its owner's nursing home care. If that's a concern, the client may want to name someone else as the account owner.
