529 For my child: who should be the "owner" - me, my wife, or both of us

[JK]

Just setup a 529 for my newborn son. I've been starting to read more about asset protection lately and was wondering who should actually be the owner of the policy. Currently it is me since I'm the financially savvy one compared to my wife and I'm the one who took the steps to set it up. However, I'm the resident (soon to be attending) and my wife does not have the earning potential...and with it, possible lawsuits.

1) Should I still be the owner of the 529 or should it be switched to my wife since if there was a lawsuit it will likely be against me (although she is also in medicine as a midlevel).

2) Can you even have joint owners of a 529? Would this make sense and decrease my chance of future liability if the lawsuit doesn't name both of us?

3) I know retirement assets (401k, IRA) generally have some protection in lawsuits, but what about 529 as a whole? How do courts typically handle 529 accounts in lawsuit cases?

[ENT Doc]

This is an interesting question.  I think it depends on your state.  I'm not sure if it's the state where you are sued or the state where the 529 is set up, assuming they're different.  Morningstar has this breakdown but it might be worth checking with your state laws.  A good umbrella policy will help too.

 

http://advisor.morningstar.com/uploaded/images/529_Table.pdf

[TheGipper]

An interesting question indeed, and further complicated in the setting of a divorce I imagine.

Not to hijack, but a related question I've often considered:

Is it possible to change the "owner" of the 529 to a child, and if so does this fall outside of additional gift tax allowance and generation skipping tax if then used by one's child for the benefit of one's grandchild.

I know MA disallows 529 change in ownership but most other states like UT allows it.  I've often wondered if my 529s end up overfunded, if I could transfer to UT529 and change the owner to a child, who could then name their kids as beneficiaries, without being hit by the GST.

 

[jfoxcpacfp]

TheGipper wrote:

Is it possible to change the “owner” of the 529 to a child, and if so does this fall outside of additional gift tax allowance and generation skipping tax if then used by one’s child for the benefit of one’s grandchild.

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The gift is to the beneficiary, not the owner. It is considered a gift if the beneficiary is changed to a different generation.

If the new beneficiary is not a member of the family of the old beneficiary, the change will be treated as a non-qualified distribution and the earnings portion of the account will be subject to income tax and the 10% penalty. In addition, the IRS may treat the change of beneficiary as a new gift to an account for the new beneficiary.

[ENT Doc]

Interesting.  So my son can't transfer unused funds to his child without incurring a penalty?  After reading more about this it seems like this may be accurate, but it's not what I was told by someone at Vanguard when I initially looked into setting this up.  Who has to pay the income tax in this situation?  I've looked on multiple websites that say there *may* be tax implications if the new beneficiary is in a different generation from the old beneficiary.  Is there a publication that speaks to this issue?  One of my intentions of setting up a 529 was to use it as a generational wealth transfer mechanism.  It would be good to know about this issue definitively so I don't overfund the darn thing.  Thanks!

[jfoxcpacfp]

ENT Doc wrote:

Interesting.  So my son can’t transfer unused funds to his child without incurring a penalty?

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That's not what I said. He can't transfer the funds to his best friend's kid without incurring a penalty. Your son's transfer would be a gift. These rules were put into place to prohibit what you're trying to do (generational wealth transfer). No reason to lock your money into a 529 if that is your goal. A trust might be more appropriate.

[TheGipper]

Johanna, to clarify.

Currently, I can/have been funding kids 529s (with spouse as owner) with up to 14,000/yr (or 28,000/yr spousal split gift) to stay under annual gift tax exemption limits.

If in the future, if I transfer to UT529 and change the owner to my oldest child (but keep beneficiaries unchanged), would this step by treated as a separate gift? I hope no.

If years later my oldest child, as the owner, changes the beneficiary to her kids, would this step count as additional gift or fall under generation skipping tax? In guessing yes, but haven't at all done my homework on this. I'm assuming this is well established law if people use 529s as an estate strategy.

[adventure]

For what it's worth, we consider some things to be just too much of a hassle for both of us to sign paperwork. For example, one of us owns all the cars, because there is no sane reason for both of us to spend more time at the DMV.

[jfoxcpacfp]

TheGipper wrote:

If in the future, if I transfer to UT529 and change the owner to my oldest child (but keep beneficiaries unchanged), would this step by treated as a separate gift? I hope no.

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No, although I'm no 529 expert, either. It is the change of beneficiaries that matters.

TheGipper wrote:

If years later my oldest child, as the owner, changes the beneficiary to her kids, would this step count as additional gift or fall under generation skipping tax?

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This would count as a gift, but the beneficiary hasn't skipped a generation. Believe it or not, the IRS is not clear on who is making the gift. See Avoiding Section 529 Pitfalls in Financial Advisor Magazine online (my favorite planning mag). You may have to set up an account. If you don't want to do so, I can share the article with you but I would have to have your email addy.

[TheGipper]

Thank you! I'll bookmark that magazine.

I had read that article before which had alerted me that I would have to claim split spousal gifts on form 709 to give 28k to 529 in one year (not automatically split between each spousal gift allowance)

It's still a little unclear how the final step will play out, but sounds like no matter who is deemed the gift giver, one could get up to 140k of leftover 529 to next generation beneficiary with a 5 year allowance.

This does seem to push the limits on the step doctrine, as I would have essentially transferred the 529 $ to my grandkids in two steps.

[spiritrider]

TheGipper wrote:

This does seem to push the limits on the step doctrine, as I would have essentially transferred the 529 $ to my grandkids in two steps.

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Just because something ends up being done in two steps does not make it subject to the step transaction doctrine.

Contributing to a 529 with your son as beneficiary and later transferring the 529 balance to your grandchildren couldn't even remotely be considered a step transaction. The fact that you have to claim new gift tax exclusions or loss of lifetime exclusion and possible gift tax liability demonstrates it can not be any attempt at duplicitous tax avoidance.

 

[ENT Doc]

Interesting point about the trust.  Will definitely look into that.  But even if there are excess funds in the scenario I described, I could still gift the remaining 529 money in my son's account to his son's 529 without incurring any gift tax, provided I stayed under the exclusion limit, right?  It doesn't make sense that I could, as a grandfather, gift 529 funds to my grandchild or pay his tuition outright without incurring any tax liability but that I wouldn't be able to roll those 529 funds into a grandchild's fund (again, provided I'm not going over the exclusion limits).  Thoughts?

[jfoxcpacfp]

ENT Doc wrote:

Interesting point about the trust.  Will definitely look into that.  But even if there are excess funds in the scenario I described, I could still gift the remaining 529 money in my son’s account to his son’s 529 without incurring any gift tax, provided I stayed under the exclusion limit, right?  It doesn’t make sense that I could, as a grandfather, gift 529 funds to my grandchild or pay his tuition outright without incurring any tax liability but that I wouldn’t be able to roll those 529 funds into a grandchild’s fund (again, provided I’m not going over the exclusion limits).  Thoughts?

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According to the article I linked above:

"If the new beneficiary is a member of the family of the old beneficiary but is in a later generation-for example, if the beneficiary is changed from a child to a grandchild-then the change is treated as a gift. The IRS is unclear at this point whether the gift is from the old beneficiary or from the account owner to the new beneficiary. Whoever is deemed to be making the gift could apply his or her gift-tax annual exclusions and even make the five-year election to mitigate the tax consequences of the gift."

[spiritrider]

It is really worse than just the IRS being unclear about who the new gift is from. They actually proposed two conflicting regulations with different people identified a the source of the gift.

1. In 1998, they proposed that since it was a completed gift to the Designated Beneficiary (DB). The rollover to the new DB should be considered a gift from the current DB to the new DB.


2. In 2008 they proposed that since the DB has no control over the account and may even still be a minor. The rollover to the new DB should be considered a gift from the Account Owner (AO) to the new DB

IRS never finalized either proposed regulations, but most professionals are inclined to recommend you follow the latest proposed regulations. Although many question how you can be subject to gift tax regulations when it is not considered part of your estate.

 

[ENT Doc]

Ok, that was my take after reading that article and from inquiring about this on Bogleheads.  It still seems like an efficient wealth transfer scheme though.  Say, for example, you have 140K still left over.  Presumably 30 years or so from now, a lot of that money will be from growth within the fund, not your original gift.  By transferring all of that tax-free growth over with no gift tax impairment in a 5 year lump sum you're gifting in the most tax-efficient manner possible.  Granted, if your goal is to reduce the size of your estate through gifting this doesn't help a lot.  But it helps you live a more comfortable life in retirement and helps your child get started out in their life without having to gift as much each year.  I'm not a fan of economic outpatient care, but I'm also not a fan of the first degree price discrimination being perpetrated by our colleges and universities.