529 Plans and Estate Planning for Education Expenses

529 Plans in Estate Planning
After Tax Reform
Qualified Expenses, Education Trusts and Differing
State Treatment
February 28, 2018
Michael T. Clear & Erin D. Nicholls

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 Methods for Education Saving
• Selecting a Planning Strategy
• Common Education Saving Solutions
• Direct Payment of Tuition: Overview
• Direct Payment of Tuition: Benefits and Drawbacks
 529 Plans
• Overview
• 5-year Front Loading Benefit
• Additional Benefits
• Drawbacks
Outline of Materials
529 ACCOUNTS IN ESTATE PLANNING

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 Expanded Provisions under H.R. 1 and Varying
Treatment
• Expanded Provisions
• Variations in State Treatment
• Variations in Plan Treatment
 Trust-Based Planning Considerations
• Structuring Education Trusts
• Incorporating 529 Plans with Education Trusts
• Other Methods for Funding Education Trusts
• Advanced Trust Option: HEETs
Outline of Materials, Continued

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 Considerations to keep in mind
o Tax planning
o Number of beneficiaries
o Age of beneficiaries
o Size of the taxable estate
o How strategies work with existing estate plan
Selecting a Planning Strategy

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o Custodial accounts
o Coverdell accounts
o Direct payments of tuition
o 529 accounts
o Trusts
Common Education Savings Solutions

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 Section 2503(e) of the Code exempts from gift tax the direct
payment of tuition to a qualified institution on behalf of a
beneficiary
 Section 2642(c)(3)(B) of the Code exempts these payments from
GST tax
– Similarly paid medical expenses are also exempt from gift
and GST tax
Direct Payment of Tuition: Overview

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 Benefits:
o Not limited to higher education
o Good way to maximize benefit to student with limited tax
consequence
 Drawbacks:
o Payment must be direct, so reimbursing a student for a tuition
payment does not qualify
o Payments for the incidental costs of education (room, board,
books) do not qualify
Direct Payment of Tuition

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 Tax-advantaged savings plan authorized by Section
529 of the Code
• Two types of 529 plans:
1. Prepaid tuition plans
2. Savings plans
529 Accounts: Overview

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 Generally an attractive vehicle for funding education
• Tax-free growth of assets
• Withdrawals were tax-free, as long as they were for “qualified”
higher education expenses
• Contributions are treated as present interest gifts, so they
qualify for the annual exclusions from gift and generation
skipping transfer tax
• 529 accounts are generally not includable in the account
owner’s taxable estate
• 5-year front loading of annual exclusion gifts
529 Accounts: Overview

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 In a given year, if you contribute more than $15,000 to any
one beneficiary’s 529 plan, you may elect to treat up to
$75,000 as if it had been made over a 5-year period
 Example 1: $75,000 contribution
o For each of the five years, you report one-fifth of the
contribution ($15,000)
o If the annual exclusion does not increase, this
contribution uses up the donor’s annual exclusion for
that beneficiary over each of the five years
5-year Front Loading Benefit

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 Example 2: $50,000 contribution
o For each of the fives years, you report one-fifth of
the contribution ($10,000), which leaves $5,000
per year for additional excludable gifts over that
period
5-year Front Loading Benefit

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 The donor maintains control over the contribution, and can
manage how the fund is invested
 Plans can benefit non-relatives and adults, in addition to minor
family members
 The designated beneficiary of a 529 plan can be changed with no
tax consequences, provided the new beneficiary is a member of
the original beneficiary’s family
o Broad definition of family
Additional Benefits

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 Higher education limitation
• E.g. tuition, fees, books, supplies, and room and
board
 If withdrawals were not for qualified higher education
expenses, they were subject to both state and federal
income tax, as well as a 10% penalty on earnings
Drawbacks

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 K-12 Education: 529 accounts can now be used for
K-12 tuition
• $10,000/year
 ABLE Account: Ability to rollover a 529 plan into an
ABLE account with no tax penalty
Expanded Provisions

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 Previously, the only vehicle for tax-free savings for K-
12 education was a Coverdell account
• Coverdell accounts have income limits, contribution
limits, contribution deadlines, and account time
limits, none of which apply to 529 accounts
Expanded Provisions: K-12 Education

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 K-12 Considerations
• It may be beneficial to open a second account for
the same beneficiary in order to pursue different
investment objectives
• Compounding benefit decreased, but it may still
make sense to funnel tuition payments through a
529 account
Expanded Provisions: K-12 Education

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 Similar to 529 accounts
• Tax-free growth and tax-free distributions, as long
as they are qualified
o Job training, health care
 Now no penalty for rolling a 529 into an ABLE
account
Expanded Provisions: ABLE Accounts

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 Every state has its own laws concerning 529 accounts
• Some states conform to the federal definition of a
qualified expense
• Other states have their own definition, which means
that there could be state tax penalties for making
withdrawals for K-12 education expenses
Variations in State Treatment

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 Other areas of potential variation:
• State tax benefits:
o Deduction versus credit
o Contribution deadlines
o Maximum aggregate plan balance
• States will likely look into whether a minimum
holding period requirement should be instituted
Variations in State Treatment

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 Areas of potential variation at the plan level:
• Ability to name a contingent owner
o Always should name one if there is an option
to do so to avoid probate court involvement in
the naming of a new owner
• Tax treatment of ownership transfer during
original account owner’s lifetime
Variations in Plan Treatment

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 Roles
• Grantor
• Trustee
• Beneficiary
Trust-Based Planning

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 Offers a solution to the drawbacks of other planning
strategies:
• Flexibility
– Education defined more broadly
– “Pot” trusts
• Management of assets
– Asset protection
– Control
– Incentive-based distributions
Trust-Based Planning

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 Benefits to trust-based planning: flexibility
o Different definitions of “education”
o To ensure desired flexibility, careful attention
should be paid to the definition of education
o When drafting the distribution standard, you
should keep in mind how the trust will be
funded
Structuring Education Trusts

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 Example 1 - Broad Definition: “Education” means elementary,
secondary, post-secondary, graduate, or professional schooling in an
accredited institution, public or private, or attendance at other formal
programs in furtherance of the beneficiary's spiritual, athletic, or artistic
education, including but not limited to payments for tuition, books, fees,
assessments, equipment, tutoring, transportation, and reasonable living
expenses
 Example 2 - Tailored to Higher Education: “Education” shall include,
without limitation, tuition, room and board, books and supplies, library
and laboratory fees, special instruction, and other related expenses
incurred during university and post-graduate education

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 Benefits to trust-based planning: flexibility
o “Pot” trusts
o Different levels of need
o Leveraging annual exclusion gifts

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 Benefits to trust-based planning: asset protection
o Not available with some of the other
education-saving vehicles
o Precatory language can express wishes
regarding education while still providing
creditor protection

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“The Trustees shall distribute to one or more of my grandchildren
(each a Beneficiary and collectively the Beneficiaries) as much of
the net income and principal of the trust as the Trustees (excluding,
however, any Interested Trustee) may at any time and from time to
time determine in such amounts or proportions as the Trustees
(excluding, however, any Interested Trustee) may from time to time
select for any purpose. It is my hope and expectation, but not my
direction, that the Trustees would consider (and, as relevant, give
preference to) making distributions for education, as so defined
under this Agreement.”

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 Incentive-based distributions
• GPA requirements
• Distributions based upon attainment of degrees
• Attain degree within a certain time period

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Incorporating 529 Plans With
Education Trusts
 The owner of a 529 account may be able to transfer
the ownership to a trust
• The account owner should verify that no adverse
tax consequences would result from the transfer

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 Trustee can make an investment decision to fund a
529 plan
 Drafting considerations:
o May want to give the trustee specific authority to
invest in a 529 plan
o Remember to consider the trust’s distribution
provisions
Education Trusts

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 Example provision regarding authority to invest:
• My Trustees may prepay the cost of tuition for any
beneficiary named in this Agreement. My Trustees
may make these payments directly to the
educational institution, or by establishing and
contributing to a Qualified State Tuition Program
under Code Section 529.
Education Trusts

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 GRAT
 Insurance
 Annual exclusion gifts
 Large Gift
Other Methods for Funding
Education Trusts

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 Section 2503(e) of the Code exempts direct payments for tuition
and health care from GST tax
• No need to allocate GST exemption
• Dynastic trust
 Tuition-only or can include medical payments
 Charitable inclusion to avoid GST taxable termination
Advanced Trust Option: Health
Education Exclusion Trusts (“HEETs”)

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 Sample distribution language:
• In making distributions for educational expenses, the Trustees
are authorized, to the extent permitted by section 2503(e) of
the Code, to provide tuition for primary, secondary and post-
secondary educations, including private schools and colleges,
graduate and postgraduate programs, trade, technical, art and
vocational schools of any type and to establish group
educational plans in which our descendants, living from time
to time, may participate
Advanced Trust Option: Health
Education Exclusion Trusts (“HEETs”)

Michael T. Clear
203-363-7675
mclear@wiggin.com
Erin D. Nicholls
203-498-4319
enicholls@wiggin.com

©2017WigginandDana
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This presentation is a summary of legal principles.
Nothing in this presentation constitutes legal advice, which can only be
obtained as a result of a personal consultation with an attorney.
The information published here is believed accurate at the time of
publication, but is subject to change and does not purport to be a
complete statement of all relevant issues.

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