By Steve Weintraub
Saturday Night Live once produced a popular skit called “The Californians” featuring Bill Hader, Fred Armisen, and Kate McKinnon. It poked fun at all things California, but especially the traffic and freeway system in Los Angeles. When a character announced the need to travel by car, the others would inquire about routing and, regardless of the answer, would respond with, “Oh, you can’t go that way at this time of day. Instead, you should take the ‘5’ to the ‘110’ to the…” In that spirit, we are suggesting that you consider taking the 529 to avoid the 706.
The 706, instead of being a real highway, is the tax form used by an executor to document and calculate any estate tax owed upon death. Just like driving on the toll roads in Orange County, few Americans have had to stop on the 706 since the exemption increased in 2018, up to $11.7 million per person today, or $23.4 million per couple. Despite whatever glitz one sees on television, only about 1,900 of the 2.8 million people who died in 2020 will be subject to estate taxes, or 0.1%.1
So, what is the problem? That wide freeway could soon narrow. The Biden administration has asked Congress to legislate a reduction in the exemption to $3.5 million per person, or $7 million per married couple.2 Absent such change, under current law the exemption is designed to sunset at the end of 2025 and revert to 2017 levels ($5.49 million per person) adjusted for inflation. Either way, the estate tax will most likely impact more people going forward than it does today.
Referring to Internal Revenue Code 529, individuals (typically parents or grandparents) can put cash into a special account earmarked to pay for education expenses. There is no federal income tax deduction for contributions, but the investment grows tax deferred until used.3
These assets can be invested in any state plan. Although California does present a 529 platform, we have found other states offer lower cost solutions. There are typically no up-front costs, and the plans frequently include cheap Vanguard Funds as the investment options.
If applied to “qualified education expenses,” distributions are tax free, for both state and federal purposes.4 Succinctly, this is a free pass for the consumer.
But wait, there’s more. Married couples can gift any individual up to $30,000 per year without gift tax consequences.5 529 Plans allow for the contribution of five years of up-front gifting, without penalty. Grandparents wishing to help assure education for their grandchildren can sock away a quick $150,000 immediately if they see the merits of 529 Plans. The gift would reduce their taxable estate, eliminating a potential $60,000 in taxes without detours that involve expenses and/or complicated strategies that might be challenged by the IRS.6
Contributions to 529 Plans, unlike most traditional gifts, allow for significant control by the donor who can change the beneficiary at any time for any reason, to any qualifying family member. If a granddaughter receives a full scholarship to college, her funds can be shifted to a sibling. If the sibling decides to go to a trade school instead of a university, no problem, the funds can be used towards that as well. If the sibling completely skips further education, the donor can name their spouse as the beneficiary to attend any accredited school…including chef training, auto racing, even highway planning!
College costs have risen at a far greater pace than the rate of inflation in the past 25 years. If you want to get in the fast lane for funding and potentially save some estate taxes in the process, consider the 529!
- “Biden Eyeing Tax Rate as High 43.4% in Next Economic Package.” Bloomberg; April 22, 2021
- Some states do allow for tax deductions, but not California
- Tuition, fees, books, supplies, room & board (most), internet access. Expanded in 2015 to include computers, 2017 to provide for $10,000 per year in K-12 tuition, and expanded in 2019 to include student loan payments and apprenticeship programs
- $15,000 per donee per year
- $150,000 X 40% tax = $60,000 in potential estate taxes