With higher education expenses continuing to grow, it can be difficult to save enough money to pay for college. However, a 529 plan is a tax-advantaged savings plan that can help save for a child's education—while reducing your estate tax liability.

What is a 529 plan?

Enacted in 1996, 529 plans are named after Section 529(b) of the Internal Revenue Code and there are two basic types: Prepaid tuition plans and savings plans. Both types of plans offer tax advantages, such as tax-deferred growth and tax-free withdrawals for qualified education expenses. But there are significant differences.

1. Savings Plans | A typical 529 plan, which allows you to save money for the beneficiary of the plan for use at any school in the future. These funds, which will accumulate over time, are to be allocated for college-related expenses (or K-12 expenses, with certain limitations).
2. Prepaid Tuition Plans | These plans allow you to prepay tuition in today’s dollars for the use of a student at a future time. Plans may be offered by states or universities, and some restrictions will apply. This type of 529 plan is less commonly used but can be an excellent solution in certain circumstances.

What are the benefits of a 529 plan?

There are several advantages associated with these plans, including:

• Tax advantages. The earnings on your contributions to a 529 plan grow tax-free, and withdrawals for qualified education expenses are also tax-free.
• Flexibility. You can use the funds in a 529 plan at any eligible institution in the United States and in some cases even abroad. You can also change the beneficiary of the plan if the original beneficiary does not need the funds or does not use them all. With the passage of SECURE Act 2.0 in late 2022, starting in 2024 beneficiaries can rollover up to $35,000 in unused 529 funds into a Roth IRA after 15 years, subject to Roth IRA annual contribution limits.
• Control. You retain control over the funds in a 529 plan. You can choose how much to contribute, when to contribute and how the funds are invested, depending on the plan type.

When you contribute to a 529 plan, you'll not only help the account beneficiary pay for school, but you may also remove money from your taxable estate. This may help you minimize your tax liability and preserve more of your estate for your heirs. Thus, if you're thinking about contributing money to a 529 plan, it pays to understand the gift and estate tax rules.

In addition, anyone with a social security number, irrespective of income, can open and contribute to a 529 plan for any beneficiary. The beneficiary can also be changed if the intended child does not go to school or does not need the funds for some reason, such as scholarships or financial aid received. Most plans have lifetime contribution limits of $350,000 or more, depending on the state.

Overview of gift and estate tax rules

The gift and estate taxes are potential federal taxes on the transfer of property from one person to another. The gift tax applies to transfers during a person's lifetime, while the estate tax is triggered at death.

Federal gift tax generally applies if you give any one person more than the annual gift tax exclusion amount, currently $17,000 in 2023 ($34,000 for married couples).

529 plans offer a special gifting feature—you can make a lump-sum contribution to a 529 plan of up to five times the annual gift tax exclusion ($85,000 in 2023, or $170,000 for married couples), elect to spread the gift evenly over five years, and avoid federal gift tax, provided no other gifts are made to the same beneficiary during the five-year period.

The gift tax and estate tax have a unified credit, which means that you can transfer a certain amount of money or property tax-free during your lifetime or at death. For 2023, the unified credit is $12.92 million per person. This means that you can transfer up to $12.92 million in property tax-free during your lifetime or at death, but any transfers above the unified credit may be subject to gift or estate tax.

Grandparents should keep the federal generation-skipping transfer tax (GSTT) in mind when contributing to a grandchild's 529 account. The GSTT is a tax on transfers made during your life and at your death to someone who is more than one generation below you, such as a grandchild. The GSTT is imposed in addition to (not instead of) federal gift and estate tax. The GSTT exemption for 2023 is $12.92 million per person and is not portable between spouses.

What happens if the owner or beneficiary of a 529 account dies?

If the owner of a 529 plan dies, the plan will pass to the designated beneficiary. The value of the 529 account will not usually be included in the decedent’s estate. If the beneficiary is a minor, a custodian or trustee will manage the account until the beneficiary reaches the age of majority. We recommend designating a successor responsible party when opening these accounts.

If the beneficiary dies before using all of the funds in the account, the funds will pass to the beneficiary's estate—look to the rules of your plan for control issues. Generally, the account owner retains control of the account. The account owner may be able to name a new beneficiary or else make a withdrawal from the account. The earnings portion of the withdrawal would be taxable, but you typically won't be charged a penalty for terminating an account upon the death of the beneficiary.

Is a 529 plan right for you?

Before investing in a 529 plan, please consider your investment objectives, as well as the associated risks, fees and expenses. A 529 plan can be a valuable tool for saving for a student’s education and reducing your estate tax liability. However, it is important to consider your financial goals, your state's plan (which may vary from the federal plan), investment options, contribution limits, flexibility and other savings options when deciding if a 529 plan is right for you.

At Busey Wealth Management, our experts have the knowledge and resources to serve your unique financial needs. To learn more about the services we provide or to discuss whether a 529 plan is right for you, visit busey.com/wealth-management.

This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.

This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.

This presentation is for general information purposes only. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.

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