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College Planning Q&A: 529s with Deceased Trustees

Also, new legislation concerning 529s and financial aid.

Susan T. Bart, 11/16/2007

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

Financial Aid Update
The president just signed legislation changing (and clarifying) the financial aid treatment of 529 savings accounts. The College Cost Reduction and Access Act of 2007 provides that, effective for the 2009-2010 academic year, a 529 savings account shall be considered an asset of (1) the student, if the student is an independent student, or (2) the parent if the student is a dependent student, regardless whether the owner of the account is the student or the parent. Parental assets are generally assessed only at a rate of 5.6%, compared with 35% for student-owned assets. The act also provides that a qualified distribution from a 529 savings account is not reportable as income or support. Prepaid tuition plans and Coverdell education savings accounts receive the same favorable treatment for financial aid purposes. The act does not explicitly address the treatment of a 529 savings account owned by someone other than the student or parent (for example, a grandparent). However, prior authority generally ignores such 529 savings accounts for financial aid purposes.

Q: My client recently died. He was the owner of 10 529 plans, one for each of his 10 grandchildren and each worth around $50,000. His wife is the successor trustee, and she died a few months before he did. He did not change the successor trustee before he died. This is a fairly large estate that will owe estate tax. Most assets were in a living trust and not subject to probate. The program manager for the plan (American Funds) in the program description states that if there is no successor trustee, then the estate of the account owner will become the account owner.

If the estate becomes the owner, and the will leaves the estate assets equally to each of my client's four children, and the four children don't all have the same number of kids is there any precedent for transferring the ownership of each of the 10 529 plans to a parent of the grandchildren (529 plan beneficiaries), even though such a distribution would not result in an equal distribution between the four parents/children?

Can Code Section 529(c)(4), which (I think) precludes the 529 plan assets from being included in the gross estate for estate tax purposes, also be used to argue that the assets were gifts to and therefore belong to the beneficiaries and that the estate is merely the owner for administration purposes, even though the estate, as owner, has the rights to withdraw the funds from the plan.

Susan: I don't know of any definitive authority. I think the "right" answer is that the accounts were gifts to the beneficiaries and the estate is merely the owner for administrative purposes, at least to the extent the estate is otherwise sufficient to cover debts, taxes, expenses and specific gifts. I would, however, consider whether I could get the children to sign a document agreeing to the proposed allocation. If a child (with fewer children) hesitated, I might mention that it would incur unnecessary fees if the executor had to go to court for instructions.

Q: Under our scenario, the client is interested in funding 13 529 accounts (perhaps 26 total if the spouse also funds) for 13 great grandchildren. The gift, estate, and GST annual exclusion rules/results make it advantageous to begin with client as the owner. Upon client's death, I would like the successor owner to be a single irrevocable trust, which would own the 529 plans going forward. The irrevocable trust would permit more broad distributions than the 529 rules and permit the trustee to collapse a plan if it deemed it appropriate to pay for other client specific educational items (such as trade school, vocational school or other items not qualifying under permissible 529 expenses). The trustee could also change beneficiaries, if appropriate, but I suspect the trust would prohibit transfers to lower generations to avoid gift issues under the regs and because the client intends to benefit only the 13 named members of this class. The client also plans on setting express parameters, even during his life, such as the age by which enrollment must begin, minimum GPA, full-time student, etc., for disbursements from the 529 plan. These parameters would also be incorporated in the irrevocable trust. If any funds remain once all beneficiaries have passed the window for using the trust funds, the remaining assets would pass to charity.

After research, I have been unable to locate any authority (PLR) that would give me comfort with the possible tax consequences, given the potential size of these transfers. It seems to me that the service could take issue with the availability of the GST and gift tax annual exclusion, where the Trustee could later change the beneficiary to another individual for whom the GST and gift tax annual exclusion was used when the original plans were funded. To the extent the Code and regs are intended to address all gift/GST exposure, perhaps the generation assignment issue is the only concern. Are you aware of any IRS authority on this planning opportunity? If not, I suspect we may recommend that the client obtain his own PLR on the issue, and particularly, the gift, GST and estate tax implications of the successor ownership outlined above. Although there certainly are matters upon which the IRS will not issue rulings, I do not believe this would fall within those matters upon which a ruling would not be issued.

Susan: You propose a very interesting technique. In a sense it is a loophole, because if you wanted to first create the trust and fund it, and then have the trust invest in the 529 plans, you would not be able to qualify gifts to the trust for the GST annual exclusion. However, by transferring the 529 accounts to the trust later, by changing the account owner, arguably there are no gift or GST consequences to the change of account owner. On the other hand, 529 gives you the flexibility to move funds among beneficiaries who are members of the same family, so I don't see the proposal as abusive.
I know of no direct authority. I think applying for a private letter ruling is the only way to be certain what position the IRS will take.PAGEBREAK

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