Qualified State Trust Programs

Otherwise Known as Section 529 Plan

California has just finalized its own program intended to comply with Internal Revenue Code Section 529 known as the Qualified State Tuition Program. The television news coverage and an article in the Sacramento Bee on Sunday, October 3, 1999, addressed the educational aspects. For more information, you can visit the website at www.scholarshare.com. For a listing of other states' programs, visit www.collegesavings.org.

You may wish to consider whether or not such a plan will provide benefits to you. The benefits of such a program as a means for saving for college are well known and somewhat self explanatory so we would like to focus your attention on some of the estate planning benefits that are associated with those types of plans more or less independent of the tuition programs. The donor is called a "participant" under the tuition plan. There are essentially two plans, one of which is the prepaid (tuition guaranty) plan and the other is called the savings plan. The savings plan is the more flexible plan and of the two presents some estate planning opportunities.

Both plans provide that contributions to the plan are completed gifts, thus qualifying the $10,000 donor/donee annual gift tax exclusion per year. In addition, you may gift five times that amount and have it spread over five years, thus giving $50,000 per donor/donee gift tax excludable. (No other gifts for those five years are excludable.)

The primary tax vehicle that generates the benefits both for college savings and under the estate planning alternatives is the investment will accumulate without being reduced by taxes as gains are earned. The gains will be taxed when they are withdrawn. If the funds are withdrawn by the students to be used for education, they are taxed at the student's then rate. If the money is withdrawn without providing for education, the gains are taxed at the donor's rate plus a penalty of between 5% to 15%. Even with this penalty, in most scenarios, establishing and contributing to one of these plans can be beneficial for estate tax planning purposes.

Beneficiaries can be changed without tax consequences to a member of the family of the original beneficiary. The definition of a member of a family is quite broad and proposed legislation (within the bill vetoed by the president) broadens it even further. Note that the family attributes are measured with respect to the beneficiary rather than the original donor. When changing a beneficiary without generation skipping from the participant, there are no estate tax consequences.

Unlike the educational IRA, the qualified state tuition program does not preclude the use of Hope and Lifetime earnings credits. However, you may not make a contribution to an educational IRA during the year contributions are made to a qualified state tuition plan on behalf of that child.

Each program is different since, in effect, there will be fifty different programs, one for each state. In order to provide for each of these benefits, only some programs are applicable.

The following chart demonstrates the advantages of front-loading the removal of $50,000 plus accumulation.
529 Account Using 5-Year Rule

Year 1

Year 2

Year 3

Year 4

Year 5

Year 20

Gift $10,000 $10,000 $10,000 $10,000 $10,000
Account Value* $54,000 $58,320 $62,986 $68,024 $73,466 $251,692
Amount Excluded from Estate $14,000 $28,320 $42,986 $58,024 $73,466 $251,692
529 Account Making Annual Gift***
Gift $10,000 $10,000 $10,000 $10,000 $10,000
Account Value** $10,800 $22,464 $35,061 $48,666 $63,359 $217,065
Amount Excluded from Estate $10,800 $22,464 $35,061 $48,666 $63,359 $217,065
Incremental Estate Tax Reduction if Death Occurs During Five-Year Prorating Period $3,200 $5,856 $7,925 $9,358 $10,107 $34,627
* 8% account growth assumptions, deposits made at beginning of year.
** 8% account assumptions, deposits made at beginning of year. There are also additional annual earnings which may be credited on gifts not yet made. Those amounts are not reflected in the account values.
*** This example does not include the appreciation within the participants estate of the as yet unmade gifts. Thus, in this example, we are isolating on the estate reduction benefit, not comparing the total value of each strategy.


As you can see, there are estate planning advantages to front loading a 529 account. Using the five-year rule for a 529 allows more to be excluded from an estate on a yearly basis (even if death occurs) than by making an annual gift to a 529. Remember that all gifts in a 529 program are considered completed gifts, so if $50,000 is given, that $50,000 plus appreciation is out of the estate immediately (subject to recapture in certain circumstances).

Chart 2 shows the worst case scenario of contribution, them removal for non-educational purposes. (Note, the participant can remove the funds.)


Day One

Value at 20 Years*



Unqualified Withdrawal***
Savings Account in Own Name $50,000 $135,730 $61,079** $135,730
UGMA Account $50,000 ($10,000 x 5) $183,565 $183,565 $135,730
529 Account $50,000 $233,048*** 




* Each account assumes a pre-tax rate of return of 8%, with the savings account earning an after-tax rate of return of 5.1% (i. e., combined tax rate of 36.25%)
** Assumes the maximum estate tax of 55% and no generation-skipping transfer tax.
*** When funds are distributed, earnings will be taxed at the beneficiary's rate. If not used for qualified higher education expenses, earnings will be assessed an additional 10% penalty.

There are limitations and caveats. Please feel free to make an appointment, at your earliest convenience, to come in to discuss your options.


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