Monthly top tips

So Says the 529 Guru

No. 17
Joe Hurley
Sunday, January 30th 2005

Question: I would like to move my daughter's college savings from one 529 plan to another. I understand that I am restricted to one tax-free rollover between 529 plans every 12 months, but still have a couple of questions. My first question concerns a 529 account that my mother (my daughter's grandmother) has opened. Before I make my rollover, do I need to make sure that "Grandma" has not made a rollover within the past 12 months? Second, can I also transfer money from my daughter's Coverdell ESA into the 529 plan, or will that be counted as a rollover subject to the 12-month rule? - Dan E.

Answer: Welcome to the world of rollovers which, in my opinion, is needlessly complex. Let's review the essential rollover rules:

Same-beneficiary rollover
Generally speaking, a withdrawal from a 529 plan is a tax-free rollover as long as the funds are transferred within 60 days to another 529 plan for the same beneficiary. (To simplify the process, most 529 plans will offer a direct "trustee-to-trustee" transfer.) However, rollover treatment is denied if the transfer occurs within 12 months from the date of a previous rollover for the same beneficiary.

Related-beneficiary rollover
A withdrawal from a 529 plan is a tax-free rollover as long as the funds are transferred within 60 days to a 529 plan for the benefit of a qualifying member of the designated beneficiary's family. This includes siblings, descendents, ancestors, aunts and uncles, and cousins. The 12-month rule does not apply in these circumstances.

Either you or Grandma will run afoul of the rollover rules if you both roll over your 529 accounts within the same 12-month span. It doesn't matter that the accounts have different owners; what matters is that the accounts all have the same beneficiary (your daughter).

Obviously, coordinating rollovers when different owners are involved can get tricky. In fact, you may not even be aware of other 529 accounts established for your daughter. An IRS legal staffer told me that the wording of the rollover rule had been recognized as a "problem," which makes me wonder if they would go after someone who gets caught in this trap.

It doesn't help that the official IRS publication on education tax benefits, Publication 970, seems to be confused on this issue. Page 53 inaccurately states: "Only one rollover per QTP [i.e. 529 plan] is allowed during the 12-month period ending on the date of the payment or distribution." The explanation should read one rollover per beneficiary, not per plan, and it should also indicate that the limitation does not apply in a beneficiary switchover.

To avoid the 12-month rule, I suggest you change the beneficiary to another family member as part of the rollover. A sibling would be ideal-you can switch the beneficiary back to the original beneficiary at any time. If there is no sibling, naming yourself as replacement beneficiary will also work, but that can create a gift tax problem when you change the beneficiary back to your daughter in the future. You should look to your tax adviser for help in this area.

Your second question is easier. A transfer from a Coverdell ESA to a 529 plan for the same beneficiary is considered a qualified distribution, not a rollover. It's still tax-free, but you do not have to worry about the 12-month rule. The same would hold true for U.S. savings bonds proceeds that are placed in a 529 plan, provided certain additional conditions are met.

Whenever placing funds into a 529 plan in connection with a 529 rollover, a Coverdell ESA transfer, or a qualifying bond redemption, be sure to provide the 529 plan administrator with information concerning the tax basis of the prior investment. The administrator needs this information to make the appropriate basis adjustment to the receiving 529 account.

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