When it comes to saving for education expenses, a 529 plan stands out as a powerful tool. And for those looking to go above and beyond in securing their loved ones’ educational future, the idea to superfund a 529 plan often emerges.
In this blog post, we will explore the ins and outs of superfunding, a strategy that allows contributors to make a substantial impact on education savings while navigating the nuances of gift tax exclusions and lifetime exemptions.
UNDERSTANDING THE BASICS OF A 529 PLAN
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. These expenses can include tuition, room and board, and other qualified educational expenses. There are two primary types of 529 plans: prepaid tuition plans and education savings plans. In this article, we’ll focus on the latter, where contributions are invested, and earnings grow tax-free.
The annual gift tax exclusion allows individuals to contribute up to a certain amount to a 529 plan without the gift counting against their lifetime exclusion amount ($13,610,000 as of this writing) and triggering the need for a gift tax return. In 2024, this exclusion amount is $18,000 per donor per recipient. This limit is adjusted annually to keep on track with inflation.
While there are no federal limits on contributions to a 529 plan, each state may impose its own limits. In Maryland, the limit is $500K per recipient, regardless of the number of accounts. In Virginia, this maximum limit is $550K.
Some states offer tax deductions for contributions to their 529 plans, providing an additional incentive for contributors. Maryland allows a deduction of $2.5K per account per donee. Virginia allows a deduction of $4K per account per donee (as of 2024).
SUPERFUNDING A 529 PLAN: WHAT SETS IT APART?
Superfunding involves making a substantial, one-time contribution to a 529 plan. The contributor can donate over the annual exclusion limit ($18K in 2024) and average the contribution across five years.
The key feature is the ability to contribute up to $90,000 per beneficiary in a single year without counting against the donor’s federal gift exclusion. Married couples can each gift the $90K, as each spouse has their own exclusion amount. They must report the donation on IRS Form 709 for each of the five years across which the gift is being spread.
Utilizing this strategy can help those with significant assets shield their wealth from potential estate taxes since they can give significant amounts in one year without counting against their lifetime exclusion.
ESTATE PLANNING BENEFITS OF SUPERFUNDING
Large estates may face estate taxes upon the donor’s passing. Superfunding a 529 plan provides a strategic way to reduce the overall taxable estate, potentially minimizing the tax burden on heirs. By superfunding a 529 plan, contributors can efficiently use a portion of this exemption, minimizing the impact of potential estate taxes.
Contributions to a 529 plan grow tax-free, and withdrawals are tax-free when used for qualified educational expenses. This creates a tax-efficient environment, maximizing the impact of the funds over time. The funds can leave the donor’s estate before the growth occurs, keeping their estate size limited.
The generation-skipping transfer tax (GSTT) is another consideration in estate planning. Superfunding a 529 plan allows contributors to allocate funds to future generations without incurring additional tax burdens.
CONSIDERATIONS FOR SUPERFUNDING
While superfunding provides a unique opportunity to make significant contributions, it’s essential to be mindful of the annual gift tax exclusion amount. Contributing beyond the annual exclusion amount may lead to the gift counting against the donor’s lifetime exclusion.
Superfunding can be a powerful strategy when contributing to 529 plans for multiple family members. Married couples with three children could, for example, give away $540K in one year without any of the amount counting against their lifetime exclusion. This would amount to $90K per child per spouse.
While $90K (5x the annual exclusion amount) is the figure being mentioned here frequently, donors can contribute less than this and still elect the superfunding provision. If they were to donate $50K, for example, they could still spread that gift across five years to not count against ther exclusion amount. Importantly, it must be spread across five years even if it is less than $90K. They cannot elect a shorter time frame even though it means not max funding the annual gift exclusion in each of the five years.
Any gifts outside of the 529 donation will also count toward the annual exclusion amount. Keep this in mind when deciding on how much to contribute. For example, a grandparent could superfund a grandchild’s account the full $90K and also giving them $15K to purchase a car in the same year will lead to $15K of the gift counting against the lifetime exclusion amount in that year.
CONCLUSION
Superfunding a 529 plan is a strategic and powerful approach to education savings and estate planning. By taking advantage of the unique features that allow for substantial contributions while navigating gift tax exclusions and lifetime exemptions, contributors can make a lasting impact on their loved ones’ educational future.
This strategy not only helps ensure tax-efficient growth and withdrawals but also positions contributors to protect their wealth from potential estate taxes. As with any financial strategy, it’s crucial to consult with financial advisors and stay informed about changes in tax laws to maximize the benefits of superfunding and secure a brighter future for the next generation.
Discuss your situation with a fee-only financial advisor.