Frequently clients inquire about the best ways to either make gifts to grandchildren during their lifetime or leave a small gift to their grandchildren at their death. One way to accomplish that gift is to leave money to a 529 Account, named for the Internal Revenue Code Section allowing for the tax favored status of such account.
A 529 Account is a savings account that is invested, income tax free, for the purpose of funding the named beneficiary’s education. The deduction does not provide any income tax benefits for purposes of your federal income taxes, but Missouri donors may qualify for a deduction for purposes of their state income taxes.
If you fund the 529 Account during your lifetime, annual gifts of less than $14,000 per donee ($28,000 per donee for a married couple) qualify for the annual exclusion for the gift tax. Additionally, donors can pre-fund up to 5 years of contributions, and elect to allocate the amount over 5 years for purposes of the gift tax annual exclusion. In other words, a donor could fund up to $70,000 ($14,000 x 5 year), in year one, and recognize the gift of $14,000 each year for 5 years without incurring any adverse gift tax results.
Funds invested in a 529 Account are invested, typically based on the age of the beneficiary, and do not incur income taxes on the income and appreciation while retained in the account. Distributions from the 529 Account which are used for qualified higher education expenses (tuition, books, supplies, and certain reasonable room and board) are also tax-free. However, if the funds are withdrawn for purposes other than qualified higher education expenses, are subject to a 10% income tax penalty.
The owner has the ability to change the named beneficiary, subject to the gift tax limits for the new beneficiary. The owner can also name the successor owner of the account upon the owner’s death.
While many clients may initial assume that a trust would be a better option for their beneficiary, the 529 Account’s favorable income tax status is an excellent substitute when the beneficiary is expected to attend college and the total funds contributed are likely to be modest.