Bailing out of the Independent 529 Plan

Change beneficiaries with no loss of benefits.
Roll the funds into a state-sponsored 529 plan. You’ll recoup your principal contributions plus or minus 2% per year, depending on the performance of the account investments. But you’ll forfeit the value of your Independent 529 discounts.
Take a refund. But note that if you use the funds for qualified college expenses, you’ll lose the tax benefits and discounts of the Independent 529. And if you use the funds for any other purpose, you’ll owe an additional 10% penalty.
In short, Independent 529 funds aren’t locked in forever, but if you withdraw them you may face some consequences.

Married with children?
Bypass and QTIP trusts can help you benefit your spouse and then your kids

The estate tax’s impact is gradually decreasing until the tax is eliminated in 2010. So it may seem that estate planning is no longer critical — but that is not the case. And unless Congress passes further legislation, the estate tax will return with gusto in 2011.

Even with the benefit of increased exemption amounts over the next five years, you and your spouse may quickly meet the exemption limits if you own a home that has significantly appreciated, have life insurance policies whose proceeds will be includable in your estate at your death or have a securities portfolio. But reducing taxes isn’t the only concern. You’ll also want to ensure your assets are distributed according to your wishes, such as first to your spouse and then to your children. A bypass trust and a qualified terminable interest property (QTIP) trust can help you achieve your estate planning goals.

1. Bypass trusts
A married individual may leave an unlimited amount of assets to his or her U.S. citizen spouse estate tax free. But if the surviving spouse dies with an estate worth more than the estate tax exemption amount ($1.5 million in 2004), the excess assets will be taxable — wasting the first estate tax exemption.

That’s where the bypass trust (also known as a credit-shelter trust or exemption equivalent trust) can help. This vehicle allows both you and your spouse to take advantage of the federal estate tax exemption, thereby reducing your estate taxes, without having to give assets to your children or other loved ones on the first spouse’s death.

Bypass trusts can provide for the surviving spouse to have almost unlimited access to the funds. Flexibility is key to ensuring the surviving spouse has funds for health care or education or to maintain a standard of living. But if the surviving spouse has other assets he or she can use, it may be best to use the funds in the trust only as a last resort. Why? Because bypass trust funds will pass estate tax free at the surviving spouse’s death.

Let’s look at an example. Suppose Jack’s estate is $5 million, Jackie’s estate is $300,000, and, at Jack’s death this year, his estate can take full advantage of the available lifetime exemption amount. If Jack has funded a bypass trust up to the lifetime exemption limit ($1.5 million in 2004), the remainder of his estate ($3.5 million) will pass to his wife estate tax free. To reduce the tax bill on Jackie’s estate, which is now $3.8 million, she should spend the bypass trust assets last because they can pass estate tax free at her death. Keep in mind that you must also consider the income tax impact, but generally the estate tax benefits will outweigh any income tax cost associated with the strategy.

2. QTIP trusts
If your assets are greater than your spouse’s (or vice versa) and you’d like to ensure they are distributed according to your wishes while benefiting your spouse after you are gone, consider using the QTIP trust instead of, or in addition to, a bypass trust. (Using both trusts together is often called an A-B arrangement.) It allows you to provide your surviving spouse with income from the trust for the remainder of his or her lifetime.

QTIP trust assets qualify for the marital deduction (and therefore pass estate-tax free) but are included in the survivor’s estate. To qualify, the surviving spouse must receive all trust income throughout his or her life.

The difference between using a QTIP trust and simply giving the assets to the surviving spouse is that, with a trust, the surviving spouse has virtually no control over how assets are distributed at his or her death.

Protection for your family
There are a number of steps you can take to care for your spouse and children after you’re gone. Bypass and QTIP trusts are just two strategies you can use. Just be sure to plan carefully for your and your loved ones’ needs before taking action.