Dynasty 529 Plans Can Build Generational Wealth

Leveraging these college-savings plans for tax-free growth combats rising education costs but families must keep up with IRS developments.

As published in Rethinking65

By Mallon FitzPatrick

A 529 plan is arguably one of the most powerful vehicles for funding higher education in the United States. These plans come in two varieties: prepaid tuition plans and college savings plans. Many of your clients are already utilizing them but what they may not know about are dynasty 529 plans. This type of college-savings plan uses the benefits of a traditional 529 plan to establish a long-term strategy for building generational wealth.

Dynasty 529 plans, which can be passed down through generations, allow investments made for educational purposes to grow for decades without being subject to income tax and estate tax. Doing so helps families cover educational expenses for children, grandchildren and extended family while combating rising education costs. Dynasty 529 plans can also be owned by trusts, which provides families with additional flexibility and control.

Before I get into the nuts and plans of dynasty 529 plans, let’s take a moment to review the basics of 529 college-savings plans.

529 Plan Benefits, Restrictions and Tax Considerations

Funds within a 529 plan grow tax-free, and there are no required distributions at any time. Withdrawals are tax-free for qualified education expenses like tuition, books, and room and board. Some states also allow tax-free withdrawals for K-12 tuition at public, private or religious schools. The account owner retains control as the student ages, with the ability to change beneficiaries and transfer ownership. A new feature ensures that 529s owned by grandparents do not affect a student’s financial aid eligibility.

Each 529 plan can only have one beneficiary, and that beneficiary may be changed at any time. Contributions to 529 plans are made with after-tax dollars and are not federally tax-deductible. However, many states offer income-tax deductions.

Anyone can contribute to a 529 plan, and contributions follow gift-tax rules for the beneficiary. Donors can contribute up to the annual gift-tax exclusion of $18,000 (as of 2024). Contributions above this threshold are subject to gift tax and reduce the donor’s lifetime exemption amount.

529s also allow for “frontloading,” which permits up to five years’ worth of annual exclusion gifts to be contributed in a single year. Contributions above this amount within the next four years are considered taxable gifts and will reduce the lifetime exemption.

Read the Fine Print

State contribution limits vary, ranging from $235,000 to $575,000. If an account reaches its maximum limit, no further contributions are permitted until the balance falls below the limit. However, additional 529s can be opened in another state for the same beneficiary or in the same state for a different beneficiary.

Investment options and fees vary by plan, so paying attention to these details is essential as they compound over time. Fees and investment choices often matter more than state income tax deductions, which are less critical than fees and investment options.

How Does the Dynasty 529 Plan Strategy Work?

Ownership Across Generations

Anyone, even a parent who is the account owner, can be the beneficiary of a 529 plan. Some savvy parents establish a plan before their child is born and change the beneficiary to the child after birth. This can count as a gift, as we will see later on. Generally, it’s most beneficial for the youngest family member to be the beneficiary, with a parent or grandparent as the owner. The plan owner can transfer ownership anytime, from parent to child and then from child to grandchild when the child is born.

Naming a successor owner ensures control of the 529 continues after the original owner’s death, helping avoid probate. Successor owners can manage the plan, change beneficiaries, and maintain flexibility. A dynasty 529 is a strategy and is not an official type of account; you won’t see a checkbox when opening a 529. However, it’s important to follow all relevant regulations to maximize the benefits.

529 plans may be combined by completing a rollover at the custodian, like a 401(k) to IRA rollover. Note that the IRS permits only one rollover every 12 months for the same beneficiary. Funds can also be transferred to a 529 plan for another child or split between two plans. This flexibility is one of 529’s most valuable features.

It’s possible to set up 529 plans for multiple family members and later combine them for a single beneficiary. However, avoid merging the plans in the same year as making contributions, as the IRS could view this as a violation of the step doctrine – treating it as one large contribution, which may trigger gift taxes if it exceeds the annual exclusion. To avoid violating the step doctrine, allow several years between making contributions and combining the plans.

Super-funding and Wealth Transfer

Anyone, including friends, can contribute to a 529 plan up to the state’s maximum contribution limit. If the plan is started early and contributions are maximized, the account could grow significantly by the time tuition payments are due. It’s a good idea to build a long-term strategy that considers the number of children, whether K-12 funds will be needed, and how much should be reserved for future generations.

For example, contributing $575,000 when a child is born could grow to nearly $2 million by the time that child reaches 18, assuming a 7% annual return. For a family with three children, this could total $6 million, growing free of taxes outside of the donor’s estate.

What are the Risks?

Changing the 529 plan’s beneficiary or owner may result in gift, estate and generation-skipping transfer tax (GSTT) consequences. Switching the beneficiary to a family member who is a generation or a second generation younger than the original beneficiary is considered a taxable gift. Changing the beneficiary to a second-generation family member subjects the 529 balance, above the 5-year annual gift exclusion, to GSTT.

The IRS has not provided clear guidance on whether changing ownership of a 529 plan results in any gift, income or GSTT tax consequences. To help avoid the potential for gift and GSTT consequences, always change the owner of the 529 before changing the beneficiary.

Be mindful that significant contributions, frequent beneficiary changes, and high balances might attract IRS scrutiny, especially if the plan is perceived as an estate-planning tool.

Some funds, up to $35,000, may be rolled into a Roth IRA for the beneficiary. In addition, excess funds in a 529 plan may be withdrawn for non-educational purposes, such as funding lifestyle expenses. In this case, the amounts contributed are not taxed, but the gains are taxable and subject to a 10% penalty. Some states have their own gains penalties. For instance, California’s is 2.5%.

Lastly, multigenerational control of a 529 plan is limited. When the ownership of a 529 plan is transferred to a new owner, it becomes challenging to control how the funds are used. The new owner might choose to withdraw more of the funds than the original owner intended. One way to get around this is to utilize trust.

Can a Trust Own a Dynasty 529 Plan?

A trust-owned 529 plan allows the trustee to manage the account by the trust’s terms. This provides more flexibility and control. A grantor contributing directly to a trust-owned 529 plan avoids issuing Crummey notices to beneficiaries; simplifying administration. The trustee can change family beneficiaries and oversee contributions, ensuring alignment with the trust’s objectives. The trust can also designate a successor trustee to maintain management and flexibility for future generations.

Certain states restrict contributions or withdrawals when a trust owns a 529 plan, which can impact flexibility. Beneficiaries are not entitled to distributions; withdrawals are left to the trustee/ The trust document should always include specific authorizations for the trustee — mainly to receive a plan as a successor owner and to roll over funds to a new 529 plan if needed.

Summing It All Up

By taking advantage of beneficiary changes, portability across generations, and flexible contributions, families can potentially use a dynasty 529 plan to strategically plan for education costs while potentially minimizing tax burdens. Yet tax and legislative changes could impact the benefits of a dynasty 529 plan, so it’s essential to weigh these possible risks alongside the plan’s ability to preserve wealth and reinforce educational values.

Mallon FitzPatrick, CFP, is a principal and managing director at Robertson Stephens and heads the firm’s financial planning center. For more information about Mallon or Robertson Stephens, please visit www.rscapital.com or email info@rscapital.com. Advisory services are offered through Robertson Stephens Wealth Management LLC. Opinions presented are those of the author and not necessarily Robertson Stephens. Please read important disclosures.