Dear Joe, I have a question I hope you can help me with: Do contributions made in a prior year to a 529 plan have any bearing on my ability to use the five-year lump sum feature in the current year? More specifically, my wife and I contributed a total of $22,000 to our son's 529 plan in 2005 (the year the account was opened). If we now want to take advantage of the five-year lump sum feature, can we contribute the full $120,000 (i.e., $12,000 per year times five years, times two donors) in 2006 without triggering any gift tax? Or, can we contribute only the difference between $120,000 and the $22,000 we contributed last year, or $98,000? -- Eric
Since neither you nor your wife previously made a five-year gifting election, your 2006 annual gift exclusion is fully preserved and you are able to take maximum advantage of the election this year. With the annual gift exclusion now set at $12,000 per donee -- up from $11,000 in 2005 -- you can contribute as much as $120,000 (combined) to a 529 plan for your son in 2006 without giving rise to a taxable gift.
The five-year election, unique to 529 plans, allows you to treat your contributions to a 529 plan as being made ratably over a five-year period for gift-tax purposes. Congress came up with this idea in 1997, recognizing that some families would have the desire and ability to save large amounts in 529 plans, but that gift-tax consequences might derail or delay their funding intentions. You are a perfect example of what Congress had in mind. With $22,000 in 2005 contributions and $120,000 in 2006 contributions, you and your wife will have transferred $142,000 out of your estates and into a tax-deferred (and potentially tax-free) investment for college. If your 529 plan's investment returns keep pace with college-cost increases, you'll already have enough saved up to pay for four years at most private colleges.
Even better is the fact that you retain full ownership and control over the 529 funds. You can revoke any portion of the account at any time, although any earnings withdrawn and not used for college will be subject to tax and a 10-percent federal penalty. It's easy to see why more than a few wealthy individuals with children or grandchildren have transferred big bucks (hundreds of thousands of dollars) into 529 plans.
A few caveats are in order for anyone thinking about "power-funding" a 529 plan.
First, understand that any other cash or property gifts you make to the 529 beneficiary will reduce the amount of annual exclusion available for your 529 contributions. If you intend to use the full five-year election amount, you should refrain from making other gifts in 2006 through 2010. Gifts exceeding the annual exclusion must be reported to the IRS, although you won't actually pay federal gift tax until you've reached $1 million in cumulative taxable gifts. Another option is to reduce your 529 contributions to a level that, when added to non-529 gifts, stays within the annual gift exclusion.
Second, remember to validate your five-year election by filing Form 709, the federal gift tax form, before next April 15. Follow the form instructions in making the election. If a married couple intends to combine their annual gift exclusions but they have not contributed equal amounts to the 529 plan, they should consent to "gift-splitting" so that their contributions are treated as made equally.
Finally, keep track of the forward gifts under your five-year election. In each of the next four years you will have already used up a portion of your annual exclusion equal to one-fifth of the election amount. And if you should die before reaching the fifth year of the election, a portion of your contribution will have to be added back for estate tax purposes.