Dodging contribution limits on 529 plans



Dear Joe, What is the maximum amount that you can put into a 529 plan? I put more than $200,000 into the New Hampshire or Vermont plan (sorry, I don't remember which) and I am very close to the maximum contribution limit. Can I go to another state and open another 529 plan or do all 529 plans apply their upper contribution limits on an aggregate basis? Please advise and thank you. -- Robert


Dear Robert,
Federal law requires that states establish maximum contribution limits to prevent people from contributing excessive amounts to their 529 plans. Many states will establish their limits under a formula that considers the highest-cost undergraduate and graduate schools in the country, resulting in contribution limits that can go above $300,000 per beneficiary.

Few states, if any, ask you about the money you have in other states' 529 plans when applying their own contribution limits. The IRS does not require that the states do so, recognizing that it would be extremely burdensome -- perhaps impossible -- to accomplish.

So what is to prevent you or anyone else from parking a million dollars in tax-deferred 529 accounts spread among several different states? In a word: nothing. There are no "contribution police" to stop you, and there are no penalties for making outsized contributions. (You may have some gift-tax issues, since contributions are considered gifts from you to the named account beneficiary.)

The problem arrives later on, when you withdraw from your 529 accounts without enough college costs to support those withdrawals. Federal income tax, and an additional 10-percent penalty tax, will be owed on the earnings portion of any "nonqualified" withdrawal. (The penalty, but not the tax, can be waived under certain circumstances including the death or disability of the beneficiary, or the receipt of a scholarship.)

If you end up taking nonqualified withdrawals, the tax and penalty will likely negate the tax-deferral benefits of your 529 investment. You might discover later that it would have been better to put your money into a mutual fund, paying the low tax rates on capital gains and dividends, but avoiding the administrative fees charged by most 529 plans.

Although very few individuals (if any) open a 529 account with the intention of using it as a retirement account, some government officials remain concerned that the risks are not sufficiently high. The U.S. Treasury Department has proposed that Congress increase the penalties under certain circumstances. If that were to happen, existing 529 accounts will most likely be exempted under the usual grandfathering protections.

One final note: I find it interesting that you cannot remember which state sponsors the 529 plan you are using. You, no doubt, receive quarterly account statements and other regular communications from the plan. This suggests that for you -- and I'm sure for many other people -- the identity of the state sponsoring the 529 plan is not important. It's the underlying investments and the level of fees that matter most. But try to commit it to memory. You really should know where $200,000 of your money is.