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.

Popular Questions


Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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