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So Says the 529 Guru
Wednesday, September 24th 2003
Question: I have three children and intend on using 529 plans to save for their college education. Can I open just one 529 account for them or do I have to open three separate accounts?
Answer: You can go either way, but the rule is: one beneficiary per 529 account. You might open an account for your youngest child, then transfer money into separate accounts for the other two children as they reach college age. Or you might open an account for your oldest child, pay his or her college expenses, then change the beneficiary to the next child.
A single account offers a couple of potential benefits:
1) If your 529 plan charges an annual account-maintenance fee, you may be able to reduce your costs by consolidating your college savings into one account. (But first check to see if you can avoid fees by signing up for automatic contributions or in other ways.)
2) Keeping the 529 funds with your youngest child may increase the older children's chances for favorable financial-aid treatment. However, some colleges count all your 529 accounts regardless of beneficiary, nullifying the advantage of this approach. The instructions to the federal financial-aid application do not provide clear guidance on this issue.
But for most people it makes more sense to open a separate 529 account for each child from the outset. Here's why:
- You can contribute more without worrying about gift tax. A $25,000 contribution to one account will require that you file a gift-tax return because it exceeds your $11,000 annual gift exclusion. Even the special five-year averaging election requires a gift-tax filing for the first year. But if spread evenly among three 529 accounts, that same $25,000 becomes three separate gifts of $8,333, falling within your $11,000 gift allowance for each child. No gift-tax returns are needed, provided other gifts don't push any recipient over the annual exclusion limit.
- You may wish to invest differently for each child. For the oldest child, you might want to be more conservatively invested, and for the youngest child more aggressively invested. With separate accounts it is much easier to establish and keep track of different asset allocation targets.
- Separate accounts help to keep things simpler and perhaps "fairer." You won't have to worry about making transfers between accounts in the future as long as college funds are used as anticipated. And consider the risk, however slight, that you might die unexpectedly. The administrator of your estate won't have to guess at your intentions if separate 529 accounts already exist.
- Many of the states offering a state tax deduction or a match for your contributions place a per-beneficiary or per-account cap on the annual benefit. Check to see if your state is one of these. Multiple accounts could lead to multiple deductions.
Question: I set up a Coverdell education savings account for my child a couple of years ago and now I want to transfer the money into my state's 529 plan so I can claim a state tax deduction. What's the process for making this transfer? Jerry, Ohio
Answer: Coverdell ESA (CESA) money comes out tax-free when equivalent contributions are made to a 529 plan for the same beneficiary. The process for moving the money is straightforward:
1) Request a withdrawal from the CESA.
2) Contribute funds to a 529 plan for the same beneficiary.
3) Treat the CESA withdrawal as a tax-free "qualified distribution" on the beneficiary's income tax return in accordance with Form 1040 instructions.
You must inform the 529 plan of the transfer, so the plan administrator can properly reduce the tax basis of the 529 account for the untaxed earnings in the CESA distribution. This way, if a taxable distribution is ever made from the 529 plan, it will pick up the earnings carried over from the CESA.
Unlike a 529-to-529 rollover, it's not required that you roll over the CESA money to a 529 plan within 60 days to qualify as tax free. Simply keep the CESA withdrawal and 529 contribution within the same calendar year. It also doesn't matter where the 529 contribution comes from-you, the beneficiary, or anyone else. In fact, to secure the state tax deduction for the 529 contribution on your return (not the beneficiary's), it may be necessary to show the money came from your own pocket.
If you do decide to transfer the CESA funds into the 529, you'll have to be careful how ownership of the 529 account is set up. You should not use the transfer as a means of regaining full ownership and control of the CESA money. Although it may have been controlled by you, the CESA was "owned" by the beneficiary. I'm not an attorney, but it seems to me that you should handle the transfer the same way you would a transfer of UTMA or UGMA money into a 529. Most 529s place special restrictions on those accounts aimed at protecting the ownership rights of the minor.
An attorney I have spoken with about this question is more circumspect. He suggests the ownership of a Coverdell ESA is so vague that it is difficult to know what is permitted until we get further guidance from Congress or the IRS. Perhaps you should find out what your own attorney has to say.