As you think about planning your estate, you probably have your loved ones top of mind. If college is part of their plan, a 529 College Savings Plan may be able to help in some unexpected ways.
When you contribute to a 529 plan, you’ll not only help your child, grandchild, or other loved one pay for college, you’ll also reduce the amount of your taxable estate. This can help minimize your tax liability, so more of your estate goes to your heirs and less goes to Uncle Sam. If you’re looking to reduce taxes while contributing to a college fund, it helps to understand the gift and estate tax rules.
Gift and estate tax rules.
If you give away money or property during your life, you may be subject to federal gift tax. Whether this tax applies depends primarily on the amount of your gift. The IRS establishes a limit on how much money you can gift each tax year to a single recipient without being taxable. This is known as the annual gift tax exclusion amount, and is set at $14,000 for 2017, and $15,000 for 2018. That means you can give up to that amount each year to as many individuals as you like, federal gift tax free.
In addition, you’re allowed a federal unified gift and estate tax credit for total lifetime gifts and bequests made at death. Federal unified gift and estate tax credit? That’s a mouthful. In short, this is the sum total of exemptions for both your taxable estate and gifts made throughout your life. In 2018, that exemption is $5,600,000.
So how does the unified credit relate to the annual gift tax exclusion? The taxable amounts of any gifts you make over your lifetime (for example, those over $15,000 in 2018) reduce the amount of your unified credit. The reduced exemption amount determines the portion of your estate that is not subject to taxation.
Giving the gift of college savings.
A contribution to a 529 plan is treated as a gift and qualifies for the annual federal gift tax exclusion. In 2018, this means you can contribute up to $15,000 to the 529 account of any beneficiary without incurring federal gift tax.
This doesn’t mean you can’t contribute more, however. It just means that anything over $15,000 will be taxable. For example, if you contribute $17,000 to your daughter’s 529 plan, you’d need to report the entire $17,000 gift on a federal gift tax return. But, that return would show that only $2,000 is taxable.
Remember that you’d have to use up your full federal unified credit — that’s the $5,600,000 in 2018 — before you’d actually have to write a check for the gift tax.
Spread the wealth.
Section 529 plans offer a special gifting feature. You can make a lump-sum contribution of up to five times the annual gift tax exclusion (so, $75,000 in 2018) and spread the gift evenly over five years. This lets you avoid the federal gift tax, as long as you don’t make any other gifts to the same beneficiary during that five-year period.
So, if you contribute $75,000 to your son’s 529 account in 2018, you can choose to have it treated as if you’d made a $15,000 gift for each year of a five-year period. That way, your $75,000 gift would be nontaxable, assuming you didn’t make any other gifts to your son in any of those years.
You can contribute more than $75,000 to a specific 529 plan in 2018, but the averaging election applies only to the first $75,000. Anything over that $75,000 would be treated as a gift in the year the lump-sum contribution was made.
As you make plans for your estate, consider whether its overall value will make it subject to estate tax. Bigger is not always better when it comes to estates! By spending down your estate with tax-free gifts now, you can support your family’s dreams in the present and leave less to be taxed in the future. Looking for ways to minimize taxes and help pay for a loved one’s education at the same time? There’s some wisdom right there.