As the holiday season progresses and the end of the year quickly descends upon us, many minds turn to the subject of giving. Grandparents in particular seek to bring joy to their grandchildren’s faces and enrich their lives at this time of year. Few things in life are as rewarding as seeing a child’s eyes light up when they get the gift they wanted, especially when you’re the one who was able to give it to them! What is arguably even more rewarding is helping to set our loved ones up for long-term success and ease some of the larger burdens they (or their parents) are likely to face as they grow up.
Giving cash directly to the children or their parents is how most grandparents approach this, but as soon as the gift is given, control is surrendered, and this can be problematic for some. Saving for college is one of the biggest concerns many parents and students have these days.
Overall inflation has been abnormally high for the past couple of years, but even the 9% high watermark of June 2022 is dwarfed by the 12% annual inflation experienced between 2010 and 2022 in U.S. college tuition rates. This inflation helps in part to explain the current crisis of student loan debt in the U.S., and it’s reasonable that grandparents would wish to keep their family out of this predicament.
Managing the size of your estate is getting more important
Generosity, estate planning and the turning of the calendar all intersect here. As the current estate tax exemption sunsets at the end of 2025, managing the size of one’s estate is starting to become more of a priority and is an additional motivation to give within your lifetime. The 529 structure solves for tax efficiency, control over use of the gift and takes advantage of continued long-term compounding.
Current gift tax rules allow for each individual to gift up to $17,000 per year per person. So, a married couple may gift $34,000 to each child and grandchild without any of it counting against their lifetime exemption of $12.92 million or needing to file a gift tax return. The 529 uniquely allows a frontloading of five years of such gifts ($85,000 per recipient, or $170,000 from a married couple).
Historically, 529 plans have been very underutilized across our society. One reason for this may be that the upfront tax benefit is not particularly exciting for most Americans. If your state has a plan, you may get some limited deduction on your state income taxes. Many states don’t have a plan, so there is no deduction on contributions, but to focus on this is to largely miss the point. The true tax benefit is not observable at the beginning but is quite significant over the course of the beneficiary’s life.
Most 529 plans are invested in college savings plans. Simply contribute, invest and target a certain account balance. Nine states offer a prepaid tuition plan for public colleges and universities. While locking in a tuition rate in advance sounds attractive, these plans are not for everyone, as they narrow the range of prospective schools from early on.
Qualified 529 expenses are more broadly defined than many may assume. In addition to tuition, funds can be used for housing, meal plans, books, supplies, laptops and even internet service provided the institution deems these items necessary for the course of study.
Solutions for overfunding concerns
One concern about 529 plans we hear raised is the danger of overfunding the account, or the funds being unused if the beneficiary decides on a different path. Given the penalties involved in using plan funds for non-qualified expenses, it is a valid question. Thankfully, the plans allow the account holder to change beneficiaries without any tax consequences so long as the new beneficiary is a member of the current beneficiary’s family. If the new beneficiary is younger than the prior one, it’s likely worth a change in asset allocation to reflect the new time horizon.
Another concern is whether such gifting has an impact on the student’s application for federal aid, which can also have a major impact on the cost of college. While 529 plans owned by parents are considered and do have some impact, plans owned by grandparents are not considered at all on the FAFSA (Free Application for Federal Student Aid) form. From a grant or aid perspective, the grandparent is simply in a much better position to gift and retain control through the 529 structure than the parent.
Congress expanded and enhanced the 529 structure
Enhancements to the original 529 structure have made this gift even more valuable. Recent legislation has seen Congress quietly expand and enhance the 529 structure as a possible long-term solution to the affordability issue in education. Back in late 2017, the Tax Cuts and Jobs Act expanded the eligibility of 529 funds to include private and parochial K-12 schooling.
This legislation was then built upon in 2019 by the first SECURE Act, which allowed 529 funds to be used to pay down up to $10,000 in student debt. The most recent enhancement came in 2022 with the SECURE 2.0 Act, which allows for unused 529 funds, starting in 2024, to be rolled over into Roth IRA assets at the annual contribution limit up to a lifetime maximum of $35,000 for a beneficiary. The account needs to have been open for at least 15 years. The importance of being able to continue to compound these assets in a tax-free environment and remove the 529-related investment and distribution restrictions should not be underestimated.
Whether the priority is reducing the size of your estate, providing for the next generation, being tax efficient or all of the above, the 529 plan should be considered a significant tool in your financial planning toolkit.
The information provided herein is for illustrative and education purposes only and is not intended to be and does not constitute specific investment advice. We urge you to consult with a qualified advisor before making any investment decisions.
Information contained herein has been obtained from sources believed to be reliable. While we have no reason to doubt its accuracy, we make no representations or guarantees as to its accuracy. The opinions and analyses expressed herein constitute judgments as of the date of this publication and are subject to change at any time without notice. Any decisions you make based upon any information contained in this publication or otherwise are your sole responsibility.
Specific securities mentioned are used as examples for illustrative purposes only and should not be construed as a recommendation. Further, it should not be assumed that investments in the securities identified and discussed were or will be profitable. Past performance does not guarantee future results. All investments involve risks including the loss of principal. Employees and related persons of FBB Capital Partners may, and in some instances do, hold positions or other interests in the securities mentioned herein.
Any forward-looking statements or projections herein are based on assumptions. By their nature, forward-looking statements involve a number of risks, uncertainties and assumptions that could cause actual results or events to differ materially from those expressed or implied by the forward-looking statements. You should not place undue reliance on forward-looking statements, which reflect our judgment only as of the date this information was published.
FBB Capital Partners, LLC (FBB) is a SEC-registered investment advisor located in Bethesda, Maryland. Additional information, including our services, advisory fees and other helpful disclosures, can be found in our Form ADV Part 2, which is available upon request or on the SEC's website at www.adviserinfo.sec.gov.
Mel brings nearly two decades of financial services and investing experience to the FBB Capital Partners team. As a Senior Portfolio Manager, Mel is responsible for managing client relationships and client investment portfolios. A native of Dublin, Ireland, Mel received his Bachelor of Commerce degree from University College Dublin. He is a CFA® and CAIA charterholder, a member of the CFA Institute and a member of the CFA Society of Washington, DC. Mel lives in Bethesda, Maryland, with his wife, Jenny, and their two children.
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