As college costs have soared, way outpacing the small gains in family income of the past decade, more and more families have turned to Section 529 college savings plans where gains are tax-free when withdrawn to pay for school.
But some 30% of those who have invested the $244 billion in 529 plans are wealthy enough that paying for college isn’t really at issue, according to a report by research firm Strategic Insight.
Many such people are using these state-run plans for another purpose: to shelter assets from the inheritance tax.
Ann Marie Etergino, managing director and financial advisor at The Etergino Group of RBC Wealth Management in Chevy Chase, Md., has been using 529s for her high-net-worth clients for years.
These plans have some “pretty good features” that make them an excellent and simple way to reduce an estate to below the taxable level of $5.43 million per person, she says.
A parent or grandparent can make gifts of up to $14,000 per year to as many people as he or she wishes and can pay those gifts ahead during one year for a period of five years, Etergino says.
That is $70,000 per gift.
A wealthy individual with eight grandchildren and seven favorite nephews and nieces can get rid of $1.05 million in assets, “without any need of an attorney or a trust,” Etergino says.
With 529s “you never give up control of that money even when you name a beneficiary,” she says.
“You can change beneficiaries later, for example if a child you named gets a scholarship and doesn’t need the money or decides not to go to college,” Etergino says.
Also, if something unexpected happens and the client needs some of that money, it can be withdrawn by the client for just taxes and a 10% penalty on any dividends and interest earned, she says.
Withdrawals from a 529, unlike an individual retirement account or a 401(k) plan, are completely tax-free if spent on college tuition or expenses, but if the money is used for other purposes, it is taxed.
James W. Rimmel, managing director of wealth management in the Pittsburgh office of UBS, also uses 529 plans with some of his high-net-worth clients as a way of reducing taxable estate assets.
He notes that it is important when grandparents are using the plans to name grandchildren and not their parents as beneficiaries.
“If you name the parents, then the money has to be included in the [Free Application for Federal Student Aid] form used for calculating student aid at public universities,” Rimmel says. “But FAFSA doesn’t ask about grandparents’ assets.”
Dave Lindorff spent five years as a China correspondent for Businessweek and has written for The Nation and Salon.com.
This story is part of a 30-30 series on tax planning strategies.