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Saving estate taxes with a 529

Posted: 2008-10-06

by Joseph Hurley

In the time left before the end of this year, you have an opportunity to reduce your taxable estate by making gifts up to your $12,000 per-beneficiary gift tax exclusion. Many Americans will miss this opportunity. Once the calendar turns over, you'll have next year's exclusions available (increasing from $12,000 to $13,000), but you'll also be leaving behind 2008's unused exclusions.

If, for example, you have six grandchildren, you can gift $12,000 in cash or other property to each of them this year, or $72,000 in total, without incurring any gift taxes. If you're married, your spouse can do the same for those six grandchildren, and together you've removed $144,000 from your combined estates, along with all future growth of those assets. Your heirs stand to gain tens of thousands of dollars (or more) that Uncle Sam might otherwise claim upon your death.

So why doesn't every well-off individual fully utilize his or her annual exclusions? No doubt it's because most people don't like the idea of giving away their hard-earned dollars. To be eligible for the gift-tax annual exclusion, the gift must be irrevocable, and it must be made without any strings attached (except for what your attorney may be able to craft through a trust or family partnership). What's yours now no longer belongs to you, and that can be a tough pill to swallow.

Unless, of course, we're talking about a 529 plan.

With a 529, you have the right to change the beneficiary to another family member, direct the use of distributions, and even ask for the money back at any time (subject to tax and 10% penalty on the earnings). Yet your contributions to the 529 plan are treated as gifts from you to the account beneficiary, and those gifts qualify for the $12,000 annual exclusion. It's quite extraordinary.

Even more amazing is that you may elect to spread large contributions (as much as $60,000 per beneficiary this year, or $65,000 per beneficiary next year) over five calendar years for gift tax purposes. This is often referred to as "accelerated gifting," and it's only available through 529 plans.

Perhaps you're thinking "so what?" Thanks to the estate tax exemption, you may not expect your estate to be subject to tax anyway. The exemption against estate taxes is $2 million in 2008, increasing to $3.5 million in 2009. And in 2010, the federal estate tax disappears entirely. So why worry about it now?

There are at least two reasons to worry. The first is that the estate tax is scheduled to return in all its fury on January 1, 2011, with the exemption retreating to $1 million. The second reason is that even when an estate doesn't owe federal estate tax, taxes may still be owed to your state. This occurs in approximately two dozen estates.

Perhaps Congress and the President will act to protect estates from tax after 2010, but neither candidate in the presidential race is supporting the permanent repeal of estate taxes. A 529 plan will continue to make a lot of sense as a way to remove assets from your estate without removing your ability to control those assets. Not to mention, it can go a long way in helping your children or grandchildren afford college.

Here are a few additional tips concerning 529 plans and gifting:

  • Count up all your gifts during the year when planning your contributions to a 529 plan. If you contribute $12,000 to a 529 plan during 2008, and make another $300 of cash gifts to your beneficiary in the same year, your total gifts are $12,300 and you have exceeded the annual exclusion. If you use Upromise, Futuretrust, the Fidelity 529 Rewards Card, or other affinity programs to sweep your purchase rebates into a 529 plan, you should count those as gifts too.
  • Be sure your contribution gets made early enough to be counted as a 2008 gift, if that is your intention. Leave enough time for your check to be received and credited to your 529 account. If you qualify for a state income tax deduction for your contribution, be sure to check the rules in your state regarding the timing of the contribution.
  • If you make 529 contributions exceeding $12,000 for a beneficiary, you may elect to spread those contributions (but not more than $60,000 for 2008) over a five-year period for gift-tax purposes. You must file Form 709 with the IRS in order to make that election. Form 709 has the same filing due dates as Form 1040. If you failed to file Form 709 for a prior year election, go ahead and file it now. There's no late-filing penalty.
  • Carefully coordinate your gifting with your spouse. You may agree to gift-splitting, but check the Form 709 instructions to determine how to indicate such consent. If your 529 contributions after gift-splitting still exceed $12,000, you and your spouse must make separate five-year spreading elections if that is your intention.

Posted October 6, 2008

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