Benefits of 529 Plans

529 Plans have benefits beyond tax-deferred earnings which make them attractive options for educational funding.

I’ve been discussing 529 plans, how they work and their benefits far more frequently with clients than I used to.  You might think that tax-deferred savings is the main benefit, along with tax-free withdrawals for qualifying higher education expenses in 529 plans. However, there are also state tax incentives, such as tax deductions, credits, grants, or exemption from financial aid consideration from in-state schools in certain states.  Forbes’ recent article entitled “7 Benefits You Didn’t Know About 529 College Savings Plans (But Should)” says there are many more advantages to the college savings programs than simple tax benefits.

1) Registered Apprenticeship Programs Qualify. You can make qualified withdrawals from a 529 plan for registered apprenticeship programs. These programs cover a wide range of areas with an average annual salary for those that complete their apprenticeship of $70,000.

2) International Schools Usually Qualify. More than 400 schools outside of the US are considered to be qualified higher education institutions. You can, therefore, make tax-free withdrawals from 529 plans for qualifying expenses at those colleges.

3) Gap Year and College Credit Classes for High School. Some gap year programs have partnered with higher education institutions to qualify for funding from 529 accounts. This includes some international and domestic gap year, outdoor education, study-abroad, wilderness survival, sustainable living trades and art programs. Primary school students over 14 can also use 529 plans for college credit classes, where available.

4) Get Your Money Back if Not Going to College. If your beneficiary meets certain criteria, it’s possible to avoid a 10% penalty and changing the plan from tax-free to tax-deferred. For this to happen, the beneficiary must:

  • Receive a tax-free scholarship or grant
  • Attend a US military academy
  • Die or become disabled; or
  • Get assistance through a qualifying employer-assisted college savings program.

Note that 529 plans are technically revocable. Therefore, you can rescind the gift and pull the assets back into the estate of the account owner. However, there are tax consequences, including tax on earnings plus a 10% penalty tax.

5) Private K–12 Tuition Is Qualified. 529 withdrawals can be used for up to $10,000 of tuition expenses at private K–12 schools. However, other expenses, such as computers, supplies, travel and other costs are not qualified.

6) Pay Off Your Student Loans. If you graduate with some money leftover in a 529 account, it can be used for up to $10,000 in certain student loan repayments.

7) Estate Planning. Contributions to a 529 plan are completed gifts to the beneficiary. These can be “superfunded” for up to $75,000 per beneficiary in a single year, effectively using five years’ worth of annual gift tax exemption up front. For retirees with significant RMDs (required minimum distributions) from qualified accounts, such as 401(k)s and traditional IRAs, the 529 plan offers high contribution limits across multiple beneficiaries, while retaining control of the assets during the lifetime of the account owner. Assets also pass by contract upon death, avoiding probate and estate tax.

7.5) Medicaid Benefit.  I’m going to cheat and add one more.  In Texas, transfers to 529 plans for CERTAIN beneficiaries are exempt as transactions for longterm Medicaid.  As with all Medicaid planning, you would want to do this at the advice of an attorney, but for situations where it fits, it is a very powerful spend down tool, especially where grandchildren are school age.

Reference: Forbes (July 15, 2021) “7 Benefits You Didn’t Know About 529 College Savings Plans (But Should)”

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Retaining Assets While Being Medicaid Eligible

Medicaid is a program with strict income and wealth limits to qualify, explains Kiplinger’s recent article entitled “You Can Keep Some Assets While Qualifying for Medicaid. Here’s How.” This is a different program from Medicare, the national health insurance program for people 65 and over that largely doesn’t cover long-term care. In this system, clients often have a goal of retaining assets while being Medicaid eligible.

If you can afford your own care, you’ll have more options because all facilities (depending on the level of medical care) don’t take Medicaid. Even so, couples with ample savings may deplete all their wealth for the other spouse to pay for a long stay in a nursing home. However, you can save some assets for a spouse and qualify for Medicaid using strategies from an Elder Law or Medicaid Planning Attorney.

You can allocate as much as $3,259.50 of your monthly income to a spouse, whose income isn’t considered, and still satisfy the Medicaid limit. Your countable assets must be $2,000 or less, with a spouse allowed to keep half of what you both own up to $130,380. Countable assets include things like cash, bank accounts, real estate other than a primary residence, and investments.  However, you can keep a personal residence, personal belongings (like clothes and home appliances), one vehicle (2 for married couple), engagement and wedding rings and a prepaid burial plot.  There are more detailed rules for countable and exempt assets, but suffice it to say most things count.

If you have too much income over the $2,382 income per month for the application, you can use a Miller Trust aka Qualified Income Trust for yourself, which is an irrevocable trust that’s used exclusively to satisfy Medicaid’s income threshold. If your income from Social Security, pensions and other sources is higher than Medicaid’s limit but not enough to pay for nursing home care, the excess income can go into a Miller Trust. This allows you to qualify for Medicaid, while keeping some extra money in the trust for your own care. The funds can be used for items that Medicare doesn’t cover.

However, your spouse may not have enough to live on. You could boost a spouse’s income with a Medicaid-compliant annuity. These turn your savings into a stream of future retirement income for you and your spouse and don’t count as an asset. You can purchase an annuity at any time, but to be Medicaid compliant, the annuity payments must begin right away with the state named as the beneficiary after you and your spouse pass away.

These strategies are designed for retaining assets while being Medicaid eligible for married couples; leaving an asset to other heirs is more difficult. Once you and your spouse pass away, the state government must recover Medicaid costs from your estate, when possible. This may be through a a claim on your probate estate (usually means the house) before assets go to heirs, reimbursement from a Miller Trust or other items.  That is a topic unto itself, albeit an important one, so see here for more information on Medicaid recovery.  https://www.galliganmanning.com/protect-assets-from-medicaid-recovery/

Note that any assets given away within five years of a Medicaid application date still count toward eligibility. Property transferred to heirs earlier than that is okay. One strategy is to create an irrevocable trust on behalf of your children and transfer property that way. You will lose control of the trust’s assets, so your heirs should be willing to help you out financially, if you need it.

Reference: Kiplinger (May 24, 2021) “You Can Keep Some Assets While Qualifying for Medicaid. Here’s How”

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Does Your State Have an Estate or Inheritance Tax?

There is a lot of focus recently on the federal estate and gift tax and the potential for changes due, and rightly so.  The tax rate is 40% of amounts gifted and left at your death above the exemption amount, which is likely to go down.  But, what a lot of people don’t consider is that some states have their own estate taxes, and in a few cases, inheritance tax.  Texas has neither, but I thought a blog on state estate and inheritance taxes would be a good follow-up to my recent blog on issues to consider when moving to a new state.  See that here:  https://www.galliganmanning.com/should-you-update-your-estate-plan-if-you-move-to-a-new-state/

Although it has fallen out of favor recently, many states still have either an estate tax, inheritance tax or some combination.  According to The Tax Foundation’s recent article entitled “Does Your State Have an Estate or Inheritance Tax?”  17 states and the District of Columbia all apply some or both of these taxes.  Hawaii and the State of Washington have the highest estate tax rates in the nation at 20%, and there are 8 states and DC that are next that apply a top rate of 16%. Massachusetts and Oregon have the lowest exemption levels at $1 million, and Connecticut has the highest exemption level at $7.1 million.    For the New York readers, the estate tax exemption is at nearly $6 million and applies rates from about 3% up to 16% depending on how far you exceed the exemption.

6 states have inheritance taxes.  Inheritance taxes, unlike estate taxes, apply a tax rate based relationship of the decedent to the beneficiary, meaning it applies even if the estate is relatively small.  Nebraska has the highest top rate at 18%, and Maryland has the lowest top rate at 10%. All 6 of these states exempt spouses, and some fully or partially exempt immediate relatives.  For you Pennsylvania readers, this could be anywhere from 0% to spouse and 15% to individuals who aren’t close family members.

Estate taxes are paid by the decedent’s estate, prior to asset distribution to the heirs. The tax is imposed on the overall value of the estate less the exemption applicable to that state. Inheritance taxes may be due from either the estate or the recipient of a bequest and are based on the amount distributed to each beneficiary.

As I mentioned earlier, most states have been steering away from estate or inheritance taxes or have upped their exemption levels because estate taxes without the federal exemption hurt a state’s competitiveness. Delaware repealed its estate tax at the start of 2018, and New Jersey finished its phase out of its estate tax at the same time, though it still applies its inheritance tax.

Connecticut still is phasing in an increase to its estate exemption. They plan to mirror the federal exemption by 2023. However, as the exemption increases, the minimum tax rate also increases. In 2020, rates started at 10%, while the lowest rate in 2021 is 10.8%. Connecticut’s estate tax will have a flat rate of 12% by 2023.

In Vermont, they’re still phasing in an estate exemption increase. They are upping the exemption to $5 million on January 1, compared to $4.5 million in 2020.

DC has gone in the opposite direction. The District has dropped its estate tax exemption from $5.8 million to $4 million in 2021, but at the same time decreased its bottom rate from 12% to 11.2%.

So, it is of course a good idea to consider reviewing your estate plan when relocating, but especially if you move to states that have estate or inheritance tax.  Talk to an experienced estate planning attorney about how estate and inheritance taxes affect you in your new state.

Reference: The Tax Foundation (Feb. 24, 2021) “Does Your State Have an Estate or Inheritance Tax?”

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