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

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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