Is 529 Plan Loophole Too Beneficial for the Wealthy?
One of the best ways to save for your children’s education is to set up a tax privileged 529 plan. A 529 plan is the only one of its kind with the privileged tax benefit of the investment gain and the distribution being free of tax. You might think that this functions in the same way as a Roth IRA, but it does not — the contribution limits and transfer allowances allow for much more in a 529. However, people simply are not aware of them.
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529 plans are intended for education purposes only. This means that should you spend any of the money on a “non-qualified” purchase, you may face income taxes on the growth, in addition to a 10% penalty. Your original principal, since contributed as after-tax, would not be subject to tax.
Each state has their own 529 plan, but you can also use a plan from another state if you choose. Each 529 plan has a beneficiary attached to it that is assigned by either the grandparents or the parents The contribution limit is $15,000 per year — this is where the loophole exists.
Although there is a limit of $15,000 per beneficiary per year, there is no limit on the amount of 529 accounts you can open. This means that you can have a 529 for each grandchild you have. Additionally, the law allows each account owner to pay up to five years’ worth of contributions upfront without triggering gift tax laws — this means that a couple can contribute $150,000 per beneficiary at one time, and for several people over.
What the wealthy use this for is to shave down their estates to reach just under the thresholds for taxable amounts. For example, the federal estate tax exclusion is $11.7 million, meaning one can gift up to this amount upon death without the recipient incurring any taxes. For instance, let’s say that your estate is above the threshold — you can create multiple 529 plans and throw hundreds of thousands of dollars into them in order to shave down the taxable estate far enough where it gets below the taxable amount.
These 529 loopholes are a great way to build generational “education” wealth. By securing the amount of money needed into a 529 plan for a child, it can be passed down to them without taxes – but it doesn’t have to be. The beneficiary on a 529 plan can always change, which means that if a grandchild does not end up needing the money, said grandchild can pass on the funds to their own children. What’s more is that during these waiting periods, the money continues to grow in the account.
Should an account grow to a considerable size, it still might be a good investment even if it is not needed for educational purposes. Think of it as the Roth IRA that was supposed to happen. Roth IRAs were originally intended to be passed down, but Congress nixed the idea and now there are laws on minimum distribution ages and how long the account can even have money in it. The same does not apply to a 529 plan. Even with the 10% penalty, it can be used as a tax advantaged investment vehicle to both safeguard education or pass on money to future generations.
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Last updated: August 9, 2021