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Paying for Education as Part of an Estate Plan: 529 Plans By Elizabeth Carrott Minnigh, Esq. Buchanan Ingersoll & Rooney PC, Washington, DC One of the most important concerns for high net worth clients is how to best pay for the costs of higher education (i.e., college or graduate school) for children and grandchildren. There are a number of means to help with the costs of education, including: (1) 529 plans; (2) payments made directly to a qualified educational institution; (3) Uniform Transfer to Minors (UTMA) accounts; and (4) trusts. 529 plans, also known as “qualified tuition plans,” are tax-advantaged savings plans sponsored by states, state agencies, or educational institutions. There are two types of 529 plans: (1) the prepaid tuition plan and (2) the college savings plan. Although prepaid tuition plans are no longer common, college savings plans remain an important option for those seeking to pay for future education in a tax-advantaged manner. College Savings Plans College savings plans are popular as they offer greater flexibility than direct prepayment to educational institutions or, where still available, prepaid tuition plans. Participants are free to choose among the available state plans and, with few exceptions, neither the contributor nor the student need to be a resident of the state whose plan is chosen. Further, plans may be moved from state to state by the owner. • Educational Institutions. The funds may be withdrawn at a future date and used for qualified higher education expenses at any eligible educational institution, including a private or public institution, whether in-state or out of state. • Covered Expenses. College savings plans cover all “qualified higher education expenses,” including: (1) tuition; (2) mandatory fees; (3) room and board; and (4) expenses incurred in connection with enrollment, including books and computers. • Front-loaded contributions. Individuals may contribute, free of gift tax consequences, up to five years' worth of annual exclusion gifts. For 2008, the amount a donor may give each year free of gift tax consequences is $12,000. A donor who contributes up to $60,000 in 2008 may elect to amortize the contribution over the next five years by filing a gift tax return showing the allocation of his or her annual exclusion with respect to each student for whom the donor has established a 529 plan. The Department of Treasury announced on January 18, 2008 that it will be providing clarification of the rules regarding this election in a forthcoming notice of proposed rulemaking. • Contribution Limits. Many college savings plans limit the aggregate amount that may be contributed. For example, current limitations include $235,000 in New York, $250,000 in Virginia, $260,000 in the District of Columbia, $305,000 in New Jersey, $320,000 in Maryland, $341,000 in Florida, and $368,600 in Pennsylvania. These limits only restrict the amount that may be transferred to a 529 plan and do not limit the amount of growth. • Investment. Each state plan is managed by one or more financial institutions. Investment options and the degree of choice as to investments vary widely by state. College savings plans are not guaranteed by the state, so the investment options are subject to market risk. • No Age Limits. Most states have no age limits for their college savings plans, so they may be created for both adults and children. Accordingly, college savings plans may be the best option to fund the graduate school education of an older child. • No Residency Requirements. College savings plans generally have no residency requirement. Louisiana is one exception. However, non-residents may only be able to purchase some plans through financial advisers or brokers. • Open Enrollment. College savings plans generally are open all year for enrollment but there may be restrictions on the timing of moving a plan to a different state. Account Owners The “account owner” is the person entitled: (1) to name (and change) the designated beneficiary of an account; and (2) to receive distributions from the account if no person is named as the designated beneficiary. An account owner may be an individual, a trust, an estate, a partnership, an association, or a corporation. Upon the death or incompetency of an individual account owner, the successor account owner will be determined either by the terms of the plan or, in the case of an individual owner, the account owner's last will and testament. Designation of Beneficiaries The account owner may designate either himself or herself or any other individual, including a non-family member, as the “designated beneficiary.” The designated beneficiary may be changed without adverse tax consequences to the owner if the new designated beneficiary is a member of the family of the designated prior beneficiary. “Member of the family” includes (1) a spouse; (2) a child or more remote descendant; (3) a sibling or step-sibling; (4) a parent or step-parent; (5) a niece or nephew; (6) an aunt or uncle; (7) a first cousin; and (8) a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. If the new designated beneficiary is one generation below the prior beneficiary, the change will be deemed to be a gift from the prior designated beneficiary to the new designated beneficiary, even though the prior designated beneficiary is not the account owner and does not control the 529 plan. If the new beneficiary is at least two generations below the prior beneficiary, GST tax consequences will also result. On January 18, 2008, the Department of Treasury announced that it will issue proposed regulations aimed at curbing abuses of rules governing changes to the designated beneficiary. Contributions A “contributor” is an individual or an entity who makes a contribution or direct allocation to a 529 plan account for the benefit of a designated beneficiary. The contributor does not need to be the account owner. Contributions to 529 plans may only be made in cash or by rolling over another 529 plan or Coverdell Education Savings Account (formerly called “education IRAs”). Contributions are not deductible for federal income tax purposes, but many states allow a state income tax deduction for a portion of the contributions made to a 529 plan sponsored by that state, or in some cases, another state. On January 18, 2008, the Department of Treasury announced that it will issue proposed regulations regarding contributions by non-individuals. Investment of Funds Funds contributed to a 529 plan grow free of income tax for federal and, in most cases, state income tax purposes. The account owner may either change investment strategies or roll over the account to another 529 plan only once per 12-month period. If the plan is rolled over to a 529 plan sponsored by a different state, the previous state may require a contributor to recapture previous state income tax deductions taken. Distributions Funds may be withdrawn from a 529 plan account by the designated beneficiary without income tax consequences if the funds are used to pay for qualified higher education expenses. On January 18, 2008, the Department of Treasury announced that it will issue proposed regulations imposing restrictions on the timing of the distribution in relation to the qualified higher education expenses paid. However, if money is withdrawn from a 529 plan and not used on qualified higher education expenses, the withdrawn amount will be subject to income tax plus an additional 10% federal income tax penalty on earnings. The Department of Treasury will be issuing proposed regulations outlining additional rules with respect to distributions to the account owner. Gift Tax Consequences A contribution to a 529 plan is considered a completed gift for gift tax purposes. The contributions are eligible for the annual gift tax and GST tax exclusion. Married donors can gift split contributions to 529 plans. Additionally, contributors may “frontload” the contributions by making a contribution of up to five times the annual exclusion amount and taking the contribution into account over a five-year period. However, there are adverse estate tax consequences if the contributor does not survive the five-year period. Estate Tax Consequences If the account owner dies before all funds in the 529 plan account are distributed, the value of the account will not be included in his or her gross estate for federal estate tax purposes. However, if a contributor elected to “frontload” the contributions, any amount prorated to the period after death would be included in his or her gross estate. In addition, although not entirely clear, the IRS has indicated that the value of any funds remaining in the account will be included in the designated beneficiary's estate upon his or her death. Income Tax Consequences On January 18, 2008, the Department of Treasury announced that it will issue proposed regulations providing guidance on how to recognize a loss in a 529 plan. Disadvantages of 529 Plans Before investing in a 529 plan, an individual should take the following considerations into account: • Annual Exclusion Limitations. If there is a competing use for the annual gift tax exclusion with respect to the beneficiary, a contribution to a 529 plan would require use of the contributor's gift tax credit. Additionally, for older donors, the ability to frontload may not be desirable if they are unlikely to survive the five-year period. In these circumstances, paying the educational expenses directly to the educational institution may be a desirable way to avoid gift tax consequences. • Donation of Appreciating Assets. Stocks and other appreciating assets may not be contributed to a 529 plan. Where an individual does not want to sell such assets (and realize capital gains) in order to fund a 529 account, an UTMA account or a trust may be preferable alternatives. • Investment Management. Prepaid tuition plans do not allow for the selection of investments. College savings plans have limited investment options and account owners are not permitted to switch freely among those options. For individuals who desire greater flexibility with respect to investments, an UTMA account or a trust may be preferable alternatives. • Primary and Secondary Education. 529 plans may not be used to pay for the expenses of primary or secondary education. To fund primary or secondary education, an individual should consider an UTMA account, a trust or paying these expenses directly to the educational institution. • Fees and Expenses. Prepaid tuition plans generally charge enrollment and administrative fees. College savings plans may charge enrollment fees, annual maintenance fees, asset management fees and additional broker's fees. Where the avoidance of such fees and expenses is desired, paying the educational expenses may be a preferable alternative. Selected State 529 Plans All 50 states and the District of Columbia offer at least one type of 529 plan. The following are some of the state plans offered. • District of Columbia. The District of Columbia offers only a college savings plan, the DC college savings plan. For more information, see http://www.dccollegesavings.com. • Florida. Florida offers two plans: (1) the Florida prepaid college plan, a prepaid tuition plan; and (2) the Florida college investment plan, a college savings plan. For more information, see http://www.florida529plans.com. • Maryland. Maryland offers two plans: (1) the prepaid college trust, a prepaid tuition plan; and (2) the college investment plan, a college savings plan. For more information, see http://www.collegesavingsmd.org. • New Jersey. New Jersey currently offers two 529 plans: (1) the Franklin Templeton College Savings Plan; and (2) the NJBEST 529 College Savings Plan. For more information on the Franklin Templeton College Savings Plan, see http://www.franklintempleton.com. For more information on the NJBEST plan, see http://www.njbest.com. • New York. New York currently offers two 529 plans: (1) New York's 529 College Savings Program; and (2) New York's 529 College Savings Program Advisor Plan. For more information on the college savings program, see http://nysaves.uii.upromise.com. For more information on the college savings program advisor plan, see http://www.columbiafunds.com. • Pennsylvania.Pennsylvania offers two plans: (1) the Pennsylvania guaranteed savings plan, a prepaid tuition plan;, and (2) the Pennsylvania 529 investment plan, a college savings plan. For more information on the prepaid tuition plan, see http://pa529gsp.uii.upromise.com. For more information on the college savings plan, see https://pa529invest.s.upromise.com. • Virginia. Virginia currently offers four 529 plans: including the Virginia Prepaid Education Program (VPEP), a prepaid tuition plan, and three college savings plans: (1) the Virginia Education Savings Trust (VEST); (2) CollegeAmerica; and (3) CollegeWealth. For more information, see http://www.virginia529.com. Information on other state 529 plans may be found at http://www.collegesavings.org among other informational websites. This commentary also will appear in the March 13, 2008, issue of the Tax Management Estates, Gifts and Trusts Journal. For more information, in the Tax Management Portfolios, see Lischer, 846 T.M., Gifts to Minors, and in Tax Practice Series, see ¶6330, Gift Tax Exclusions, Deductions and Tax Computation, and ¶6350, Estate Planning.

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