Leveraging Legacies

     For many people, saving for retirement was once a top priority. Now, having reached retirement, they find that their resources actually exceed their needs and they can provide financial assistance to others. Some retirees find satisfaction in supporting their favorite charities, their children or both. Still others find great pleasure in helping their grandchildren, especially with post-secondary education funding. In fact, more than one grandparent has said if I knew how much fun grandchildren were, I would have had them first!

Section 529

     The law recognizes this special grandparent-grandchild relationship, offering several ways to facilitate financial generosity. In this article we review Internal Revenue Code § 529 (Section 529).
     Depending on your unique circumstances, there may be significant tax and non-tax benefits available under Section 529. Otherwise known as Qualified State Tuition Programs, Section 529 plans are administered at the state government level. Each state may design its own Section 529 plan (or possibly multiple plans) within certain federal parameters.

Tax Benefits

     You may contribute up to $60,000 in a single year ($120,000 through gift-splitting if you are married) per grandchild to a Section 529 plan without triggering any gift taxes, as long as you make no further gifts to that grandchild for five years. [Note: If you do not survive the fourth year following this lump sum gift, then a pro-rata portion will be included in your estate.]
     Once invested, your contribution to the Section 529 plan grows tax-free as long as your money stays in the plan. When distributions are made to pay for qualified education costs, such withdrawals are made federal income tax-free. [Note: Like the rest of the Economic Growth and Tax Relief Reconciliation Act, this enhanced Section 529 benefit is scheduled to sunset on December 31, 2010, absent reenactment.]

Non-Tax Benefits

     Unlike some traditional arrangements for gifting to minors under state uniform transfer to minors statutes, contributions to Section 529 plans remain under your control for the life of the plan. Under many traditional arrangements, control transfers to the beneficiaries once they reach legal adulthood (age 18 in most states). Depending on their level of personal and financial maturity, a lump sum distribution in any amount at that time could spell disaster.
     Under a Section 529 plan, however, not only do you decide when, for whom and why withdrawals may be taken, but you can even reclaim the plan proceeds for yourself in whole or in part down the road as a non-qualified withdrawal. While such a withdrawal will be subject to partial income taxation plus an additional 10% excise tax, this may be a small price to pay for financial flexibility.
     As with all wealth transfer techniques, there is no one size fits all solution. Competent counsel can help you sort through the options, alternatives and potential pitfalls of Section 529 plans.