By Jason R. Johns, Esq.

Posted:  May 6, 2022

If you’re worried about protection from creditors or inheritance taxes, consider the 529 account, which can be a useful estate planning tool.

You may already be familiar with a 529 plan (also called a “qualified tuition plan” or QTP), a savings plan used for a child’s or grandchild’s educational expenses. Opening a 529 savings plan has many advantages and is a valuable estate planning tool including specific advantages for Pennsylvania residents with a Pennsylvania 529 Investment Plan or a Pennsylvania Guaranteed Savings Plan. Pennsylvania’s 529 plans accept contributions until all Pennsylvania 529 plans for the same beneficiary reach $511,758. Once the account balance reaches the aggregate limit, no more contributions are permitted, but the earnings may continue to accumulate.

Retaining Control Over a 529 Plan as the Account Owner

The account owner of the 529 plan retains control over the 529 plan

account, unlike direct gifts to the beneficiary or complicated trust funds. The account does not transfer to the beneficiary when the beneficiary reaches a particular age. Instead, the account owner gets to decide whether and when to make distributions and they can change the beneficiary to a member of the beneficiary’s family, including to the account owner. This effectively lets the account owner revoke the gift, if they choose, by changing the beneficiary to themselves.

There are no income limits, age limits or time limits on contributions. The beneficiary does not need to be of college age and can already have a college degree. The absence of an income limit on contributors clearly makes 529 Plans particularly attractive to higher income families, who also are likely to make above-average use of the savings plans.

Income Tax Treatment

The contributions to a 529 plan grow free of Federal and Pennsylvania income taxes while they remain in the account and when used for qualified expenses. Qualified educational expenses include college, graduate, professional, or continuing education tuition and up to $10,000 per year in K-12 tuition in addition to expenses, such as books, supplies, equipment and room and board if the student is enrolled on at least a half-time basis. Non-qualified distributions are subject to ordinary income taxes at the recipient’s tax rate and a 10% tax penalty. The penalty is only levied on the earnings portion of the distribution, not the full amount of the distribution. 

Monies deposited into a 529 plan are “after-tax” dollars, meaning that they are monies on which you have already paid any applicable Federal income tax. The contributions are therefore not treated as a Federal income tax deduction; however, they are also not treated as income to the plan beneficiary at the time the monies are deposited into the plan. Although contributions to a 529 plan are not subject to a Federal income tax deduction, they are eligible to be deducted from Pennsylvania income tax. Pennsylvania allows a Pennsylvania income tax deduction for contributions into a 529 plan up to $16,000 per beneficiary, per year. Married couples can deduct up to $32,000 per beneficiary, per year, provided each spouse has taxable income of at least $16,000.

How to Use a 529 College Savings Plan in Your Estate Plan

529 plans also provide unique gift and inheritance tax benefits, and unlike other gifts, the account owner retains complete control over the contributions. A contribution to a 529 Plan is treated as a completed gift for gift tax purposes, however the owner nevertheless retains the right to recover the funds if the beneficiary does not attend college, the donor needs the funds, or for any other reason. Most other methods of avoiding estate taxes—such as creating an irrevocable trust—require that you give up control over the property. In this way, the 529 plan can be an especially flexible tool for reducing your estate taxes, so long as you have loved ones who are likely to have significant educational expenses in the future.

529 plan assets are exempt from the federal estate tax. Contributions to a 529 plan are treated as completed gifts for tax purposes and are immediately removed from the donor’s estate.

Contributors can give up to the annual gift tax exclusion, without incurring gift taxes or using up part of the lifetime gift tax exemption. 

If the beneficiary is a grandchild, contributions may result in generation-skipping transfer taxes, but the annual and lifetime exemptions and tax rates are the same as for gift and estate taxes. Generation-skipping transfer taxes apply if the beneficiary is two or more generations younger than the contributor or if the beneficiary is at least 37.5 years younger than the contributor. There is an exception if the grandchild’s parents are deceased at the time of the transfer.

The transfer tax exemptions for 2022 are as follows: 

  1. $12,060,000 ($24,120,000 for married couples) federal estate tax exemption and a 40% top federal estate tax rate. 
  2. $12,060,000 ($24,120,000 for married couples) Generation Skipping Transfer tax exemption and a 40% top federal Generation Skipping Transfer tax rate. 
  3. Lifetime gift tax exemption is $12,060,000 ($24,120,000 for married couples) and a 40% top federal gift tax rate. 
  4. The annual gift tax exclusion amount is $16,000 ($32,000 for married couples). 

However, unless Congress acts to extend the exemptions, they are set to revert back to $5 million for tax years after 2025. 

Federal law offers a five-year election for 529 plans (also known as superfunding), which allows a donor to treat his contributions to a 529 plan made in one year as being made ratably over a five-year period, with the goal of not incurring gift tax. A gift tax return must be filed to make this election. If the donor makes the election, only one-fifth of the total contribution would be reported on the return for the year in which the contribution was made. The donor would then report an additional one-fifth of the total in each of the succeeding four years. The contributor may be unable to make additional gifts to the beneficiary during the five-year period, unless the prorated gift is less than the annual gift tax exclusion amount. If the contributor dies during the 5-year period, part of the contribution may be included in the contributor’s estate.

Specific Advantages for Pennsylvania Residents with a Pennsylvania 529 Plan

The transfer of ownership of either a Pennsylvania 529 Investment Plan or a Pennsylvania Guaranteed Savings Plan resulting from the prior owner’s death is exempt from Pennsylvania inheritance tax. (See 24 P.S. §§ 6901.316(b), 6901.302).  However, this exemption will not apply to a 529 account opened in another state.

Assets held in a Pennsylvania 529 plan are not counted when determining state financial aid for college. Assets in any other state 529 plan are counted. Pennsylvania 529 assets are also protected from creditors in Pennsylvania. Assets in out-of-state plans are not protected.

The major advantage of using a 529 plan as an estate planning tool is that while the money in a 529 account is treated as though it is no longer your money (for example, it is not part of your taxable estate), as the account owner, you still retain control over the plan. In other words, you can invest the money as you see fit, withdraw the money as needed and you can change the beneficiary of the plan. 

For more information about estate planning, contact the attorneys at Anderson & Labovitz, LLC at (412) 209-3200 or visit our website at Jason Johns will be happy to discuss the process and cost with you and, at a minimum, give you a free consult to discuss the best planning strategies.