Guaranteeing a quality education to a child or grandchild is one of the greatest legacies a person can provide. Parents and grandparents recognize this, of course, and many want to give younger generations the advantages that go along with a quality education, whether that includes undergraduate studies or continuation into graduate or professional school.
There are different methods of accomplishing this important goal, and fortunately, the tax code currently offers some attractive incentives. And especially for high-net-worth individuals who may be concerned with keeping their financial legacy intact for future generations, there are also some important estate planning aspects to education funding that deserve careful consideration.
529 Plans
Since their launch in 1996, 529 education savings plans have been an increasingly popular tool used by parents and grandparents alike to provide tax-advantaged accounts for funding for the education costs of the next generations. Plans vary by state, and each state administers its own version, but many states permit funds from another state’s plan to be used for qualified education expenses in their state. Many states offer two types of 529 savings plans, a pre-paid tuition plan, as well as a more flexible education savings account plan. Growth and compounding of funds deposited in the savings plans are not taxed, and when distributions are made for qualified educational expenses, these are not counted as taxable income for either the plan owner (perhaps a parent, grandparent, or the student) or the beneficiary (the student).
Since their inception, several improvements have been made to 529 plans. A significant one happened in 2017, with the passage of the Tax Cuts and Jobs Act (TCJA), which expanded the permissible use of funds in the plan to include tuition and other expenses of private, K–12 schools, not just colleges and universities (up to $10,000 per year).
Additional enhancements to 529 plan rules came most recently in the Setting Every Community Up for Retirement Enhancement 2.0 Act (SECURE 2.0 Act), signed into law in 2022. Prior to this time, it was not uncommon for unused funds to remain in a 529 plan following the graduation of a beneficiary. But, since the funds could only be withdrawn on a tax-free basis for the purpose of paying qualified educational expenses, plan owners were forced to accept a 10% penalty plus ordinary income taxes if they wanted to access the funds. A provision allowing changes of beneficiary—often to a younger sibling or other family member—was somewhat helpful, but the problem still remained. But with the passage of SECURE 2.0, there are more alternatives for those whose intended beneficiaries have all graduated, but balances still remain in the plan.
The revised law allows unneeded 529 balances to be rolled over to a Roth IRA, effectively transforming the funds from an education-funding-only status to a more long-term purpose: retirement funding. There are a few conditions that must be met when doing such a rollover:
- the 529 Plan must be at least 15 years old (for example, opened for a young child who is now a college grad);
- the beneficiary of the 529 Plan must also be the owner of the Roth account;
- the owner of the Roth account must have earned income equal to the amount of the rollover;
- rollovers in any given year cannot exceed the allowable amount for Roth IRA contributions ($7,000.00 in 2025);
- there is a $35,000 lifetime maximum for such rollovers.
For estate planning purposes, 529 plans can be a helpful tool. Gifting a 529 plan can accomplish two purposes: 1. transferring assets out of the taxable estate and 2. creating a plan for managing education expenses. Especially since these plans can now be used to fund private K–12 education, grandparents with very young grandchildren can gift plans to the parents, moving assets to the next generation while also keeping annual gifts under the gift tax exclusion ($19,000 for 2025; $38,000 for couples). Those with multiple grandchildren can gift up to this amount for each grandchild. Using this as a part of the annual gifting strategy—especially if started when the grandchildren are young—can allow for transfer of significant assets out of the estate.
529 plans can also allow for making up to five years of contributions in a single year, allowing an accelerated wealth transfer process if needed. While this means that during the five-year term, the donor won’t be able to make additional gifts to the same plan, when the term is over, the strategy can be repeated, if advisable. “Bundling” deposits in this way also allows for faster compounding and growth, since a larger amount of money is being put to work at one time. Note that different state plans have different limits on the maximum aggregate funding amount.
Educational Trust
Another tried-and-true method for incorporating education funding into the estate plan involves the use of an irrevocable trust to hold assets for the benefit of children or grandchildren. For high-net-worth individuals, such a trust may offer some advantages over a 529 plan:
- Greater investment flexibility. While 529 plans often have limited vehicles available for investment, the trust can be designed to accommodate a wide variety of asset types.
- Distribution flexibility. While 529 plans must be used solely for educational purposes, trusts can be constructed to allow for the distribution of assets for purposes other thaneducation, including medical expenses, maintenance, and support.
- Protection of assets. Assets can remain in the trust even after the student finishes school, protecting funds from creditors, divorce, or reckless spending.
- Incorporating life insurance. Trusts can also hold a beneficiary’s interest in other family wealth transfer vehicles, including life insurance.
With the assistance of a qualified estate planning professional or attorney, an irrevocable educational trust can be established and funded with annual gifts that meet the exclusion limit. Trusts may be established for as many beneficiaries as needed, and each trust can receive up to the exclusion limit each year without triggering gift tax. Assets placed in the trust are no longer considered part of the taxable estate, and the grantor has the ability to specify the conditions under which trust assets may be transferred for the benefit of the beneficiaries.
Thinking about the Lifetime Exclusion
There is an alternative strategy that can be of great assistance for those who are concerned with keeping their taxable estate below the lifetime exclusion limit for the benefit of their heirs. Paying the distributions directly to the child or grandchild’s educational institution. The primary benefit of paying tuition directly to an institution is that it does not count towards a beneficiary’s annual gifting exclusion amount, which can allow for significant gifting above and beyond that figure, often without the obligation to file gift tax returns (currently about $13.9 million per individual, about $28 million for couples).
To learn more about these and other methods of incorporating education funding into estate planning, please contact your WealthCrossing advisor.
