Get answers about 529 assets and Medicaid qualification, plus putting 529s in revocable trusts.
I work with an older gentleman who would like to establish 529 accounts to fund college for his grandchildren and to remove assets from his estate both for estate tax purposes and for purposes of qualifying for Medicaid in the future if he goes into a nursing home. While his assets do not exceed the current federal exclusion of $5,250,000, they do exceed the state estate tax exclusion in his state of residence, which is only $1,000,000. If he is the account owner, will the assets in the 529 accounts count for purposes of Medicaid qualification? Would it be better for him to establish a trust to own the 529 accounts?
Each state administers Medicaid with its own rules. To qualify for Medicaid, the applicant must meet certain qualifications. Generally, the applicant must be over 65, blind, disabled, or the parent of a minor child, and must meet the financial need tests. When a person applies for Medicaid, the state values the applicant's "resources" to determine if they are less than the state's threshold amount, which may be as low as $2,000 or $3,000. Certain assets, such as a homestead or a car, are considered exempt. The federal regulations define "resources" as "cash or other liquid assets or any real or personal property that an individual owns and could convert to cash to be used for support or maintenance" (20 Code of Federal Regulations § 416.120, § 416.1201). The federal regulations further explain:
(1) If the individual has the right, authority or power to liquidate the property or his or her share of the property, it is considered a resource. If a property right cannot be liquidated, the property will not be considered a resource of the individual (or spouse).
20 CFR § 416.1201(a)(1).
Because the account owner could withdraw the section 529 account assets and use the proceeds for support or maintenance, section 529 savings account assets should be counted as a resource. Each state, however, will reach its own conclusion on whether to count section 529 savings account assets, but the overwhelming trend is to count them as resources.
If your client funded 529 accounts that were owned by another individual or by a trust, there is essentially a five-year waiting period before those assets would be disregarded for Medicaid eligibility purposes, because transfers made by the applicant within the last 60 months are subject to a "look back rule."
If an applicant for Medicaid is determined to have assets in excess of the threshold amount because of transfers within the look-back period, then the applicant is disqualified for a period determined by dividing the value of the transferred assets by the average monthly private-pay rate for nursing facility care in the state. This penalty period can be longer than the look-back period.
Thus a potential applicant should generally wait until the expiration of the look-back period before applying for Medicaid. Your client might, for example, make gifts to 529 accounts owned by someone else, but retain sufficient assets to provide for his own support, including, at a minimum, nursing home costs for five years.
As this table summarizes, there are other considerations--including beneficiary and tax issues--to take into account when deciding how to set up the 529. For instance, if another individual is the account owner, he or she will have the ability to withdraw the funds for any reason, including his or her personal use. The account owner also controls changes of beneficiary. The account owner does not owe any fiduciary duties to the beneficiary of a 529 account. Thus if one makes a gift to a 529 account with another individual as the account owner, one is placing a lot of trust in that person to use the funds as intended. Often a grandparent may trust a child to be the account owner of the accounts for his or her children, but a child may be unlikely to change the beneficiary of any unused funds for his or her children to the grandparent's other grandchildren (the child's nieces and nephews).
If a trust is the account owner, the trust imposes fiduciary duties on the trustee to follow the directions in the trust. (See my November 2003 column "How to Make a Trust an Account Owner of a 529 Account.") Thus if the trustee withdraws funds from a trust-owned 529 account, the funds would still be subject to the terms of the trust and could not be used by the trustee for his or her personal use. If the trust is for only one beneficiary, then the trustee could not change the beneficiary of the 529 account, but could distribute the 529 account to the trust if the 529 account is not needed for the beneficiary's higher education (subject to income tax and the penalty tax). If the trust is for multiple beneficiaries, then the trustee can change the beneficiary of the trust-owned 529 accounts from one beneficiary of the trust to another beneficiary of the trust. Generation-skipping transfer ("GST") tax consequences may result if the trust is not exempt from GST tax and makes distributions, including distributions from a 529 account to a grandchild or more remote descendant of the donor.
On the tax side, while gifts to 529 accounts owned by an individual will qualify for the gift tax annual exclusion (currently $14,000 per individual) and, if the gift is to a grandchild or more remote descendant, the generation-skipping tax ("GST") annual exclusion (currently $14,000 per individual), gifts to trusts may or may not qualify for these annual exclusions. Gifts to "2503(c) Trusts" will qualify for these exclusions, but 2503(c) Trusts must give the beneficiary a right to withdraw at age 21. Further, a 2503(c) Trust can have only one beneficiary. (See my January 2009 column.) Gifts to specially designed Crummey Trusts (see my September, October, and November 2009 columns) can qualify for the gift tax annual exclusion.
If a grandchild is the beneficiary, a Crummey Trust solely for that grandchild can also be designed to qualify for the GST annual exclusion, but a shared trust for multiple grandchildren cannot qualify for the GST annual exclusion. With the GST exemption now at $5,250,000 for 2013 and subject to inflation adjustments, many clients have GST exemption to burn. A client who does not plan to fully use his or her GST exemption could create a shared trust for grandchildren and assign GST exemption to it to avoid GST tax on gifts to the trust and distributions from the trust.
Another disadvantage of funding a trust and having the trust invest in 529 accounts is that contributions to the trust will not qualify for the five-year election, which allows a taxpayer to make five years' worth of annual exclusion gifts to a 529 account in one year. With the federal estate tax exclusion at $5,250,000 for 2013 and subject to inflation adjustments, many clients have federal estate tax exclusion that they will not be using. A client who does not expect to fully use his or her federal estate tax exclusion could make gifts to a trust that do not qualify for the gift tax annual exclusion. To the extent the client has federal estate tax exclusion remaining, such gifts would not result in federal gift tax. (Only one state, Connecticut, still has a gift tax.)
Because your client's assets are under the federal estate tax exclusion, your client may wish to use any assets that are not needed for his support (and at a minimum, enough for five years of nursing home care) to create a shared trust for his grandchildren. The trust can then invest in 529 accounts. Your client would assign GST exemption to the trust. If he wanted to immediately make gifts in excess of the annual exclusion, he could use his estate tax exclusion to make such gifts. Your client would be required to file a gift tax return to report any taxable gift and to assign GST exemption to the trust.
Are there any benefits to a revocable trust owning the 529 account?
A typical estate planning revocable trust permits distributions to the grantor during the grantor's life, and upon the grantor's death provides for the revocable trust assets (including any assets added to the revocable trust by reason of the grantor's death) to be distributed to one or more beneficiaries.
The trust becomes irrevocable upon the grantor's death. The advantage of naming a revocable trust as the account owner, or as the successor account owner upon the grantor's incapacity or death, is that a revocable trust will provide for a succession of trustees, and therefore a succession of account owners. For creditor protection purposes and Medicaid qualification, a 529 account owned by the revocable trust should be treated the same as a 529 account owned by the grantor of the trust. The disadvantage of having a revocable trust as the owner rather than the grantor is that there is some uncertainty about the tax consequences of a revocable trust being the account owner. Further, problems could result if the trust is not thoughtfully drafted with the 529 accounts in mind; the trust should provide instructions for how the 529 accounts are to be managed, including when distributions should be made, when the beneficiary should be changed, and to whom.
If the revocable trust becomes the account owner by reason of the contributor's incapacity, no gift tax consequences should result from the change of account owner. First, the section 529 contribution was treated as a completed gift to the section 529 beneficiary when initially made. Second, under current law there is no provision for imposing gift tax upon a change of account owner.
If the revocable trust is the account owner, the section 529 savings account should not be included in the grantor's estate upon the grantor's death, at least if the 529 account cannot be used to pay estate taxes, debts, and claims. Section 529(c)(4) provides: "No amount shall be includible in the gross estate of any individual for purposes of chapter 11 [estate tax chapter] by reason of an interest in a qualified tuition program." The Proposed Regulations provide: "Except as provided in paragraph (d)(2) of this section [regarding the five-year election], the gross estate of a decedent dying after June 8, 1997, does not include the value of any interest in a QSTP which is attributable to contributions made by the decedent to such program on behalf of any designated beneficiary" (Prop. Treas. Reg. § 1.529-5(d)(1)). There seems little doubt that section 529 was intended to override the more general provision of Internal Revenue Code section 2031, which includes in a decedent's estate the "value at the time of his death of all property, real or personal, tangible or intangible, wherever situated."
Some individuals, however, have expressed concern that a section 529 savings account owned by a revocable trust would be included in the grantor's estate under Code section 2036 or Code section 2038, which would generally apply to include assets of a revocable trust in the grantor's estate. While I believe that the very specific language of section 529 should override sections 2036(a) and 2038(a)(1) just as easily as it overrides section 2031, I know of no authority on point.
If the revocable trust would permit the trustee to take a nonqualified distribution from the section 529 savings account after the grantor's death and use the proceeds to pay the grantor's debts or estate taxes, then one might also worry about whether section 529 overrides Code section 2041, which includes in the grantor's estate property over which the grantor had a general power of appointment. A "general power of appointment" generally means any power exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate and includes a power exercisable to pay the estate tax, or any other taxes, debts, or charges that are enforceable against the estate. Again, section 529 appears to override all of the estate tax inclusion provisions of the Code, including section 2041, but I know of no authority on point. Any potential application of section 2041, however, could be avoided by prohibiting the trustee from using section 529 savings accounts to pay debts or taxes.
If, notwithstanding any tax concerns, a revocable trust is designated as the successor account owner of a section 529 savings account, careful attention must be given to ensure that the trust contains appropriate provisions permitting the trustee to manage the section 529 savings account as the grantor intends.
First, if the trust may become the account owner during the grantor's life, the trust should explicitly permit a distribution from the section 529 savings account to the section 529 beneficiary. Second, if the grantor wants the trustee to have the ability to change the beneficiary, the trust should state who are permissible alternative beneficiaries and under what circumstances the grantor would want the beneficiary changed. Third, the trust should state whether or not the trustee has the power to take a nonqualified distribution and retain the proceeds in the revocable trust, potentially for use in satisfying the grantor's needs. Fourth, if it may be desirable to make additional gifts to the section 529 savings account during the grantor's incapacity, the trust should explicitly grant such power to the trustee. The grantor may also wish to grant such gift-making powers to the grantor's agent under the grantor's durable power of attorney.
Upon a grantor's death, the revocable trust assets are generally distributed to one or more trusts or beneficiaries. The trust should contain explicit instructions as to which successor trust or beneficiary should become the account owner on the grantor's death. The section 529 savings account should pass only to a trust of which the section 529 beneficiary is a beneficiary, which is permitted to make distributions for the beneficiary's higher education. The section 529 savings account should not pass to a trust qualifying for the marital deduction (unless the spouse is the section 529 beneficiary). Once the section 529 savings account is transferred to the successor trust, the trustee will not have authority to change the beneficiary of the section 529 savings account to someone who is not a beneficiary of that trust, unless the trust explicitly permits otherwise. Careful consideration should be given to defining the permissible class of successor beneficiaries, particularly if a subtrust with a smaller class of beneficiaries becomes the successor account owner upon the death of the grantor.
Further, if the grantor lives in a community property state, community property issues may need to be addressed.
The revocable trust should also contain provisions authorizing the trustee to hold a section 529 savings account as an investment, to change investment elections, and to roll over the account to a different 529 program.
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.