What happens when you gift money to a 529 plan?

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Q. I have leftover money in my son’s 529 plan. What can I do with it? Also, one may give $15,000 to an individual, per year without triggering gift tax filings. How does this play with a 529 plan?
— Mom

A. These are a great questions.

Let’s go over how 529 plans work.

When you set up your 529 plan, you choose the beneficiary, said Jeanne Kane, a certified financial planner with JFL Total Wealth Management in Boonton.

In general, it can be anyone regardless of their relationship to the person who sets up the account, she said. It can even be you.

“The only requirement is that the beneficiary must be a U.S. citizen or resident alien and have a Social Security number or federal tax ID number,” she said. “Only one beneficiary is named per 529 plan.”

If you have leftover funds in a 529 plan after the beneficiary goes to school — or if the beneficiary never attends college — you have several options for the money.

First, you can just take it out, but you would be responsible for paying taxes on the gains in the account as well as a 10% penalty, Kane said.

Or you can change the beneficiary on the 529 plan.

She said there are no tax consequences or penalties when you change a 529 plan beneficiary to a qualified member of the beneficiary’s family. These are a spouse, child, stepchild, foster child, adopted child or a descendent, a son- or daughter-in-law, siblings or step-siblings and more.

“If you need the money, you can take it,” Kane said. “You’re the owner of the funds and can use them as you see fit. However, you will take a hit from taxes and penalties.”

If you don’t need the money, she recommends you pick someone else in your family to benefit.

“The cost of college is so expensive these days that there may be any number of relatives who would be extremely grateful for these funds,” she said.
Now, to gifting.

Kane said contributions to 529s are considered completed gifts for tax purposes from the donor to the beneficiary named on the account.

“There is a very small chance that you would ever have to pay gift tax,” she said. “You would need to have a very large estate and gift a large amount of money over your lifetime. Gift taxes are owed by the gift giver, not the recipient.”

In 2022, the annual gift tax exclusion allows you to gift $16,000 per year to an individual, she said. If you’re married, you and your spouse could gift $32,000 to an individual. The lifetime gift tax exemption is now $12.06 million per person.

“Gift tax works like a cup and saucer,” she said. “The cup is your annual exclusion, and the saucer is your lifetime exemption.”

Each year you have a cup that can hold $16,000, she said. If you gift more than $16,000 to an individual, then any amount over the $16,000 would overflow the cup and land in the saucer. The saucer can hold up to $12.06 million.

You won’t be responsible for paying gift tax on any gift that you make to 529 or other gift until the amount in the saucer reaches the lifetime gift tax exemption limit, Kane said.

You would need to report the overflow amount above the annual exclusion to the IRS, she said.

“For 529s specifically, you are allowed to gift a lump sum of up to five times the annual exclusion or $80,000 per person — $16,000 x 5 = $80,000,” she said. “You would need to elect to spread the gift evenly over five years and not make any other gift to the same beneficiary during that time to avoid potential gift tax.”

If you have a very large estate, you need to be aware of the potential tax implications of making gifts, she said. However, most Americans don’t have estates this large so unlikely that gift tax would be an issue for gifts or contributions to 529s, Kane said.

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This story was originally published on Jan. 10, 2022.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.