How To Superfund A 529 College Savings Plan

 

What Is “Superfunding” a 529 Account?

Named after Section 529 of the Internal Revenue code, 529 plans are tax-advantaged savings accounts, operated by both individual states and educational institutions, for the purpose of saving for qualified education expenses.  For an overview of 529 plans and several other types of education savings accounts, see the related post, Understanding Educational Savings Choices.

Here, we’ll talk more specifically about the details of 529 plans, and also what it means to “superfund” these accounts.

Each state-run 529 plan, administered in conjunction with a brokerage firm or mutual fund company, is unique.  There can be tax advantages to opening a 529 account within your own state’s plan, but investors are not limited to using the plan run by their home state. You can open a 529 account directly through the plan administrator, or through a financial advisor, which comes with the added benefit of professional advice and support.

Federal tax rules allow, in general, annual “gifts” of up to $14,000 per year, per beneficiary, to be exempt from the Gift Tax.  This is the annual amount one individual can “gift” to another without needing to report or pay tax on it.  That translates to mean anyone – parents, grandparents, aunts, uncles, friends, etc. – can contribute funds to a 529 account, up to that annual maximum of $14,000 per beneficiary. However, there is a special tax rule applied to 529 accounts that allows contributors to “front load” up to five years’ worth of contributions into these education accounts in a single year, without the penalty of paying the Gift Tax.  (For more on the Gift Tax see here.  )

This is known as “superfunding.”  Here’s an example of how it works:

A couple hopes to be able to pay for their two children, ages fourteen and sixteen, to attend their colleges of choice after high school.  Smartly, these parents opened a 529 account within the first year after each child was born, but they have not had the earning capacity to add much money into these accounts until last year, when the father got a huge promotion at work and the mother published the book she had been writing for too long .  First, the couple beefed up their retirement savings with the extra income produced by these accomplishments. Now, they would really like to put as much money as possible toward education expenses, while taking full advantage of whatever tax breaks are applicable. And they want to do it as quickly as possible, because college is just two years away for their oldest.

Here’s how they can do it:

First, each parent can gift $14,000 to each child. This is called gift splitting, a taxation rule that allows a married couple who otherwise acts as one unit economically (e.g., filing taxes jointly) to give as individuals, without having to report the gift. This means that each child’s 529 account will get a boost of $28,000.

Second, within the parameters of gift splitting, these parents can also “superfund” both kids’ accounts. Five years’ worth of contributions at the annual individual limit of $14,000 from each parent, results in a hefty deposit of $140,000 per child. This total contribution of $280,000, ten times the annual exclusion amount for ordinary giving under the Gift Tax, is saved for education.

Note: To take advantage of gift splitting and superfunding within IRS parameters, investors need to file Form 709 to elect “gift splitting” and to notify the IRS that the amount gifted is in accordance with the superfunding of a 529.

 

This article is for informational purposes only and should not be construed as tax or investment advice. Consult with your own tax advisor and investment advisor to determine what is best for you and your situation.