Monthly top tips

So Says the 529 Guru

No. 6
Joe Hurley
Sunday, March 9th 2003

Question: Which IRS form(s) should be used to report a $65,000 gift that my husband and I (married, filing jointly) made to our son's 529 and ESA in 2002? We did it to take advantage of the tax law's 5-year forward spread election provision ($55,000 single/$110,000 married maximum contribution over a five-year period). Wittsmom on the Savingforcollege.com Message Board

Answer: Ah yes, gift taxes. How many of us have had to worry about filing gift-tax returns in the past? Not many, I would guess. However, for anyone contributing to 529 plans or Coverdell education savings accounts (ESAs), gift taxes become a concern. That’s because your contributions to a 529 or an ESA are considered gifts from you to the beneficiary of those accounts.

Fortunately, the annual gift exclusion allows each of us to gift up to $11,000 to any other individual in a year without requiring a gift-tax filing, and gifts made via a 529 plan or ESA qualify for the annual exclusion. (Some gifts that are made through trusts do not qualify because they are gifts of a “future” interest.) Remember that the $11,000 exclusion is per-donor/per-donee. If you and your husband had each gifted less than $11,000 to your son during the year (including 529 and ESA contributions), no gift tax returns would be required and you could go merrily on your way.

But because you exceeded the exclusion limit, you and/or your husband will have to file Form 709, the federal gift-tax return, with the IRS by April 15. If necessary, you can request an extension. Gift-tax returns are confusing, but here are some guidelines:

• There is no such thing as a joint gift-tax return. You and your husband must each look at your own gifting history to determine your filing requirements and how much, if anything, to report.
• Spouses can agree to split all gifts made during the year. By so doing, you will pick up one-half of your spouse’s gifts, and vice-versa. Look for the spot on Form 709 where the consenting spouse must sign. Splitting gifts is usually a good idea when one spouse has exceeded the annual exclusion limit and the other has not. By splitting, both spouses may succeed in staying below the annual exclusion limit.
• Anyone making more than $11,000 in 529 contributions in a year for a beneficiary can elect to spread those contributions (not in excess of $55,000) over a five-year period for gift-tax purposes. This is an attractive option, because it permits 529 contributors to make higher upfront contributions while often avoiding gift-tax problems. You must file Form 709 in order to make the election, even if its effect is to bring you below the annual exclusion limit. You do not have to file Form 709 in subsequent years unless your gifts, including the pro-rata 529 contribution, exceed your annual exclusions.

So let’s take a look at your particular situation, Wittsmom. You haven’t supplied a spouse-by-spouse account of the contributions made on behalf of your son, so I will describe three plausible scenarios:

Scenario 1: You contributed $55,000 to your son’s 529 account, and your husband made $10,000 in combined 529/ESA contributions.

• File Form 709 for yourself, following the instructions in electing five-year averaging for your $55,000 contribution. This involves checking Box B on Schedule A and attaching some basic information about your contributions.
• For gift tax purposes, you are deemed to have made $11,000 in 529 contributions in 2002, and in each of the subsequent four years 2003 through 2006. Assuming you made no other gifts to your son in 2002, the annual exclusion will fully offset the gift.
• Your husband is not required to file Form 709 because his total gifts are only $10,000, less than the $11,000 annual exclusion. Your husband will have his full annual exclusions available in years 2003-2006, but you will not, so you will want to be sure that future gifts are made by him, not you.

Scenario 2: You made all $65,000 in contributions (assume $63,000 to 529 plans and $2,000 to the ESA) and your husband made none. Even if you elected five-year averaging, it would only apply to $55,000 of the 529 contributions, and you would be stuck reporting the $10,000 excess as a taxable gift. So you will want to split your gifts.

• You and your husband file separate Forms 709, indicating consent to splitting gifts, so that each of you is treated as contributing $31,500 to the 529 plan and $1,000 to the ESA.
• On your separate Forms 709, elect five-year averaging of the 529 contributions, so that only one-fifth, or $6,300, is reported as a gift for last year.
• Total gifts for each of you, including the ESA contribution, are now $7,300 ($6,300 plus $1,000). Your $11,000 annual exclusions easily cover these gifts.

Scenario 3: You and your husband each made the same amount of gifts on a separate basis, perhaps by making the contributions from one joint checking account.

• This scenario is the same as Scenario 2, except you do not have to go through the added step of splitting your gifts.

I could pose some even more complex gifting scenarios, such as reporting generation-skipping transfers when grandchildren are involved, or applying your $1 million lifetime exemption when your gifts exceed the annual exclusion, but I think I’ve said enough for now. A professional tax adviser can provide any help you think you might need.

Question: I contributed $575 to a 529 plan and its current value is now $400. I recently received notice that my account will be charged a $30 annual account fee. I'm peeved. I have two other accounts (401k and money market) with the company that runs this 529 plan and I’m not charged a fee for those investments. Can I transfer my money to another 529 plan that doesn't charge fees? CH

Answer: It’s no wonder you’re looking to avoid that fee. Thirty dollars on a $400 account equates to a 7.5% expense ratio! There’s not much chance that the future investment performance can overcome that burden. Of course, you probably should have recognized this problem when you opened your 529 account. Every 529 savings plan discloses its fees and expenses in its enrollment materials.

Depending on the program, account maintenance fees can range from as low as $5 to as much as $50 a year. The fee recognizes the fact that there truly are costs in maintaining your account (try counting up the postage on all the statements and notices the program sends out to you). And those costs are as high for a low-value account as they are for a high-value account.

Yes, you will be able to find a number of 529 plans that do not impose an annual account maintenance fee, and you have the option of transferring your 529 account to one of those programs without triggering federal tax or penalty. (For comparing fees among programs, try our easy-to-use 529 Evaluator) But anyone looking to move money between 529 plans should be sure to investigate the rules surrounding withdrawals and rollovers, including the possibility of transaction charges and state tax recapture.

The good news for you is that there is a simple way to avoid the annual account maintenance fee without moving your money to a different 529 plan. Your 529 plan (which I’m not naming here) will waive the annual fee if you commit to a minimum monthly contribution to your 529 account through payroll deduction or automatic monthly transfers from your checking or savings account. Many other 529 plans offer this feature as well.

High-balance accounts may also qualify for a fee waiver, depending on the particular 529 plan. The cut-off is typically $25,000, although it’s higher in some programs and lower in others. Some investors will consider consolidating multiple 529s under one child’s name to create a higher balance and avoid separate account fees. The money can be transferred to accounts for other family members at a later time.

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