Starting a 529 plan for your children, nieces, nephews or grandchildren can be a great way to help them save for college, vocational school or graduate school. However, your good intentions can come back to bite you if you don't know the gift-tax implications of contributing to a 529 plan. Knowing the annual exemptions allows you to maximize your contributions without owing Uncle Sam.
Annual Gift-Tax Exemption
The annual gift-tax exemption allows you to contribute a specified amount to each person you give to without triggering gift taxes. Contributions to 529 plans count against this annual limit. The gift tax adjusts periodically for inflation. For example, if your annual gift-tax exemption is $13,000 and you contribute $15,000 to a 529 plan for your son, $2,000 would be subject to gift taxes. However, if you contributed $9,000 to your son's 529 plan and $9,000 to your daughter's plan, you wouldn't have any gift-tax implications.
When you contribute more than the annual limit to a 529 plan, you can opt to average the contribution over five years to avoid gift-tax consequences. For example, if you contributed $50,000 to a 529 plan and the annual gift-tax exemption was $13,000, you would normally have triggered gift taxes on $37,000. However, using the five-year method, you are treated as having made a $10,000-per-year contribution over each of the next five years, putting you $3,000 under your annual limit.
Even if you go over the annual gift-tax exemption with your contributions to a 529 plan, you will not owe any gift taxes unless the resulting gift tax exceeds your unified credit. The unified credit is your lifetime exemption from the gift tax and estate tax. For example, if your unified credit is $1.5 million and the gift tax on your 529 plan contribution is $5,000, your unified credit drops to $1.495 million for use against future gift and estate taxes. Only after you exhaust the credit do you actually pay the gift tax.
No Education Exception
A gift-tax exception does apply to gifts made to any person for educational expenses. The exception applies to gifts made to anyone, not just a relative. However, to qualify, these gifts must be made directly to the educational institution. Since 529 plans do not go directly to an educational institution, your gifts don't qualify for this exception.
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