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The 529 Plan – Your Legacy, Funding Education, and Your Retirement

Do you have a 529 College Savings Plan? A 529 plan is a tax exempt, college savings account for a designated beneficiary, which could be a child, grandchild, great-grandchild or even a great-great grandchild. Before you call your financial advisor to have a check distributed for the designated beneficiary’s college expenses, you may want to rethink spending down your 529 plan account completely. A couple of reasons not to spend down your 529 plan include: needing those funds when your income decreases and you are in a lower tax bracket in retirement, or you might want to use it to fund the education of your children’s children.

In Chart A, we show the initial investment of $10,000 added to four different accounts: a taxable account, a 529 Plan, a Roth retirement plan and a pre-tax retirement account. The taxable, 529 and Roth accounts must all pay income taxes on the original investment, but the 529 and Roth accounts do not pay taxes on the earnings.

CHART A

chart a

Now, take a look at Chart B, which assumes that the individual has contributed the same $10,000 to each account annually for a period of 45 years. It’s interesting to note that the Roth retirement and the Pre-tax retirement AFTER TAX values are the same assuming that that the investor is in the same tax bracket before and after retirement. In reality, most people will be in a lower tax bracket when they retire. It makes sense that the investor is doing the smart thing by contributing to retirement accounts first maximizing your contributions.

Chart B also highlights the scenario of spending the money within the 529 account for other needs in retirement, such as a house or other expenses. After the withdrawal penalty and ordinary income taxes deducted, the investor will have approximately $1 million more than if he/she kept those funds in a taxable account.

CHART B

chart b

Let’s assume that your child graduates from college, or perhaps your child doesn’t need the funds for college. Now you have funds remaining in your 529 plan. Your 529 account can be transferred for the benefit of grandchildren and the funds could be distributed tax free. You might also decide to give money to your child for the purchase of a home. If your child is in a low tax bracket, you’ll save taxes by having the withdrawal reported to your child, and not to you. Your child will be subject to the 10% penalty on top of the regular income taxes. Keep in mind that the money in this account has been growing tax free for years!

529 accounts also offer a tax savings as they are not included in an estate tax calculation. Individuals with more than $5.3 million in assets, are assessed 33% federal estate taxes and another 10% state taxes for an estate worth more than $2.5 million. By keeping your money in a 529 account, your children and grandchildren can benefit, but at the same time you can remove funds as needed in the future. If you were to die today, you would have no federal estate taxes due. You would have a modest Maryland inheritance tax due. However, assuming you live 15 – 25 years, you will have an estate tax problem in the future. You may also tap into a 529 account for yourself if you run out of money or if your retirement income isn’t sufficient.  You will pay the tax and penalty, but it’s likely you will be in a lower tax bracket during your retirement years.

We’ve worked with many estate planning attorneys who have heavily endorsed this strategy of utilizing 529 accounts as a way to remove money from an estate, while at the same time having the option to pull funds back if you think you might need it in the future. Contact us to learn how we can help you set up and manage your 529 plan account.

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