Expected addition to the the family

By: Savingforcollege.com


Dear Joe, We are expecting a new addition to the family later this year. If we want to open a 529 for the yet to be born child, what is the best way of doing so and maxing our $30,000 contribution to it (without the need to file Form 709 or worry about gift taxes)? Thanks for your help. H.S.


Dear H.S.,

Congratulations in advance. Someone—I don’t recall who—once quipped that the best time to open a 529 is nine months before the child is born. It sounds like you wish to follow that advice.

The conventional approach is to wait until the child is born and has been assigned a social security number. You and your spouse then would EACH contribute up to $15,000 during the year to a 529 plan to take maximum advantage of your gift-tax annual exclusion. That’s a combined total of $30,000 for 2018. Be sure to consider any other non-529 gifts made to the child during the year as those would consume part of your annual exclusion, leaving less to cover your 529 contributions.

Also be sure to check your state’s rules to see if you might be eligible to deduct your contributions or claim a credit for them on your state income tax return. You may have to take specific steps to qualify for the maximum state tax benefit.

For federal tax purposes, it doesn’t really matter if you and your spouse open separate 529 accounts or one combined account. Most 529 plans, however, do not accept joint ownership, and a combined account will likely require that you designate one spouse as owner. It is generally simpler to keep all your family’s 529 accounts under a single owner, but the possibility of a future divorce, separation, or other financial discord must be considered.

Regardless of the how the 529 account is titled, you can each write checks to it from your separate bank accounts in $15,000 amounts. Or you can write a $30,000 check from a joint bank account since that would normally be treated as coming equally from both spouses.

Alternatively, either you or your spouse could make the $30,000 contribution from a non-joint bank account and consent to “split gifts” for the year. Gift splitting requires that the donor spouse file a federal gift-tax return, Form 709, and have the non-donor spouse sign the form to indicate consent. The result is that all gifts from either spouse are considered made 50/50. Although this is a simple process, you have indicated that you prefer to avoid filing Form 709, and I can’t fault you for that.

A special five-year election is available to taxpayers who wish to front-load their 529 accounts with even more money without creating a taxable gift. A taxable gift is one that exceeds the annual exclusion. Although normally subject to gift tax, you have a large lifetime exemption—currently $11.2 million—to apply against taxable gifts.

Under the five-year election, your 529 contribution is spread ratably over five years for gift-tax purposes, allowing you to contribute as much as $75,000 ($150,000 for a married couple) to a 529 plan without exceeding the annual exclusion amount. The election is popular among parents and grandparents who wish to jumpstart their 529 plans with substantial contributions. However, it does require that you, and possibly your spouse, file Form 709 for the election year disclosing details about your 529 plan contributions. And you will need to keep track of your election amount in future years.

The less conventional approach for someone during the pre-natal period is to open the 529 account now and name yourself as beneficiary. Once the child is born, contact the 529 plan and request that the account beneficiary be changed to the child. The advantage to this approach is that you get your college-savings money invested sooner.

Naming yourself as beneficiary might even offer a way to make large initial contributions while avoiding the hassle of a five-year election. Each year, simply move a portion of your self-beneficiary 529 account (Account #1) to the child’s 529 account (Account #2). The gift occurs when the funds are moved to Account #2, not when Account #1 is initially funded. (The general understanding is that you can’t make a gift to yourself.) By keeping the amount of the annual transfers between accounts #1 and #2 below your available gift-tax exclusion, you avoid the need for a five-year election.

I hesitate suggesting this last approach because the IRS has announced its intention to guard against tax “abuses” in 529 plans, and this may be perceived as one. Be sure to discuss it with your own tax professional first.

Original Post: 2013-04-16 Updated 2018-03-07