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Estate Taxes and the Five-Year Election

Plus, a middle-taskforce, best 529s, and more.

Susan T. Bart, 05/15/2009

College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to advisorquest@morningstar.com.

President Obama wants the United States to lead the world in percentage of adults with a college degree by 2020. The Middle Class Task Force, led by Vice President Joe Biden, is focusing some of its attention on "Making College More Affordable for Our Families," the topic of an April 17, 2009 Middle Class Task Force meeting.

In furtherance of the administration's commitment to making college affordable for the middle class, Vice President Biden has asked the Treasury Department and the Secretary of Education to study ways of making 529 accounts more effective and reliable.

"We aren't interested in empty promises. We need real, substantive ways to reinvest in student aid and putting money directly into the pockets of students who need help affording a college education," said Vice President Biden. "That's why today I am asking the Treasury Department and Secretary of Education to look into 529 plans and ways to make them more effective and reliable. Their analysis will examine how people save in the 529s, whether they are taking appropriate approaches to risk, and try to identify options and best practices for helping these funds be there for families when they need them."

The Best and Worst
Morningstar has issued its annual article on the best and worst 529 plans. The five best selected by Morningstar are:

Ohio College Advantage
Indiana CollegeChoice 529 Direct Savings Plan
Utah Educational Savings Plan Trust
Virginia Education Savings Trust
Virginia CollegeAmerica 529 Savings Plan

In assessing 529 plans, Morningstar looks for:
* Sensible allocations among stocks, bonds and cash that are appropriate for the age of the beneficiary.
* Diversification across major asset classes, including exposure to foreign bonds, real estate investment trusts and Treasury Inflation-Protected Securities.
* Low fees.
* Varied investment options.
* Quality investment options with experienced managers, a history of good stewardship and sensible strategies.

Question: Can a qualified distribution be made from a 529 savings account to repay a student loan?

Susan: Not currently. However, there have been discussions in Washington about changing the law to permit 529 savings accounts to be used to repay student loans.

Question: In 2006, my client contributed $120,000 to a 529 savings account for his grandchild. Client's spouse made a split-gift election, and both client and client's spouse made the five-year election. Client died last year, and at the time of his death the account was only worth $60,000. How much is included in the client's estate?

Susan: Section 529(c)(4)(C) states that:

(C) AMOUNTS INCLUDIBLE IN ESTATE OF DONOR MAKING EXCESS CONTRIBUTIONS. --In the case of a donor who makes the election described in paragraph (2)(B) and who dies before the close of the 5-year period referred to in such paragraph, notwithstanding subparagraph (A), the gross estate of the donor shall include the portion of such contributions properly allocable to periods after the date of death of the donor.

Because of the split-gift election, Client is treated as having contributed $60,000, or $12,000 per year. Because Client survived into the third year (2008), the contributions attributable to the first three years are excluded from Client's estate and only the contributions attributable to 2009 and 2010 ($24,000) are included in Client's estate.

It appears that $24,000 is included, even though the value of that portion of the account (2/5 of 1/2) was only worth $12,000 on the date of death. Section 529 includes a portion of "contributions," not a portion of the value of the account on the date of death. The result, unfortunately, is that estate tax may be assessed on money that isn't there.

In addition, because the gift was to a grandchild, the executor should allocate GST exemption to the portion of the account included in the decedent's estate to avoid the imposition of a GST tax, in addition to the estate tax.

 To comply with certain Treasury regulations, we state that (i) this article is written to support the promotion and marketing of the transactions or matters addressed herein, (ii) this article is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (iii) each taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.

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