The 529 College Savings Account (“529 Plan”) is an estate planning and college savings tool that has its place in a grandparent’s well-rounded estate plan, but the pros and cons should be considered before heading down to your local bank or opening an account online. In addition, as an Elder Law practice, we also want you to be informed about the affect a 529 Plan may have on your long term care Medicaid eligibility.
As a college savings tool, the 529 Plan has an advantage over a grandparent paying tuition directly in that funds from the 529 Plan can be used for room and board, books, and supplies – not just tuition. These are all considered “Qualified Education Expenses” under the rules. Another “pro” from the college student’s perspective is that when money from the 529 Plan is pulled out and used for Qualified Education Expenses, neither the gain nor the principal (original investment) is subject to federal income tax. The gain may or may not be subject to state income tax (depending on which 529 plan you chose). If the gain is reportable as state income, the grandchild will report it on his or her individual state tax return.
As an estate planning tool, some grandparents use the 529 Plans to make sure they are taking advantage of their annual gift tax exclusion, which in 2017 is $14,000/year/donee (receiver of the gift). If a grandparent chooses to set up a 529 Plan, he or she needs to set up a different account for each grandchild. Therefore, in 2017, a grandparent could gift $14,000 to each grandchild’s 529 Plan and none of these gifts would count toward the lifetime exclusion amount or require a gift tax return. Once invested, the money in the 529 Plan grows tax free.
The downside to the 529 Plan is that not every grandchild goes to college. If the funds are not used for Qualified Education Expenses, the one who set up the 529 Plan gets to choose who gets the money – themselves or their beneficiary (such as a grandchild). The one who gets the funds will be taxed (federal and state) at ordinary income tax rates and will have to pay a 10% penalty on the earnings (gains) portion because the funds were not used for Qualified Education Expenses. The principal portion (initial investment) is not subject to tax or penalty because the initial investment in a 529 Plan is made with post-tax dollars.
Some grandparents like the idea of the 529 Plan because the plans are revocable, and the grandparent can get his or her money back at any time. However, as noted above, if funds are simply returned to the investor and not used for Qualified Education Expenses, the person who withdraws the funds will have to claim the earnings portion on his or her tax return and pay a 10% penalty on the earnings.
As an Elder Law practice, we also want to include a brief note about how investment in a 529 Plan might affect your ability to qualify for benefits that defray the cost of long term care. We are concerned not only about your estate plan and your grandchild’s future, but also about the rising cost and increasing number of regulations you will face should you or your spouse ever need long term care. Arkansas Medicaid will generally treat your 529 Plan accounts as “countable” assets should you ever apply for Medicaid to pay for your long term care. Because 529 Plans permit you to take the money back, those funds will be considered available to pay for your nursing home expenses and other medical expenses. If you are concerned about maximizing Medicaid eligibility you should discuss with an Elder Law attorney your desire to use 529 Plans. You may even wish to make someone else the owner of your 529 Plan accounts. If you establish the 529 accounts under your own name, and later transfer ownership of the account to someone else (or even use the account to pay for college expenses), your Medicaid eligibility may be restricted by the “look-back” rules, which cover 60 months prior to application for Medicaid.