Recently, my clients announced that their son and daughter-in-law were having twins. They were incredibly proud and highly motivated to start saving for their education. I told them about the 529 college savings plan which also allows tax-free distributions for private elementary and high school. The 529 plan provides an excellent tool where approved educational expenses like tuition, books, room & board, and even a laptop computer may be funded, while offering tax-deferred investment returns and tax-free distributions.
Annual gifting rules limit 529 gifts at $18,000 per year ($36,000 per couple) in 2024, which is adjusted for inflation in the future. But what if you need to fill a 529 plan in a hurry because costs have now doubled with twins?
Superfund it! Under current tax laws, ‘Superfunding’ a 529 college saving account allows you to make five years of contribution (5 x $18,000 = $90,000) (for couples, 5 x $36,000 = $180,000) at one time, while still qualifying for the annual gift tax exclusion. This allowed our clients to contribute $180,000 to each child. With two children, that totaled $360,000. Lastly, both clients (grandma and grandpa) could contribute this amount making the total $720,000 for the two children.
Imagine the potential for growth that a lump sum of $180,000 would do to help your child’s college fund if you did this when they were born. For example, if you did not make any other contribution and the account earned 6% when compounded annually for 18 years, your child would have approximately $573,000 in their account when they entered college.
While superfunding can make sense for some, there are a few things to consider.
First, you should only consider super funding if you have the money and are not sacrificing your retirement savings. There are a limited number of people who can afford to do this without jeopardizing other goals.
Second, your kid may not choose to go to college. Remember that private elementary and high school tuition are now included. There are also ways to transfer to other beneficiaries while avoiding tax penalties but it’s complicated so discuss this with your tax or financial advisor. For more information see our blog post, Multiple Generations Can Use 529 College Savings Plans.
Finally, be aware of what you may be giving up in terms of state tax benefits. In the state of Minnesota, you have two options: 1) You get a tax deduction of up to $1,500 for single filers or up to $3,000 if married filing jointly. 2) For smaller investors, you get a tax credit of half of contributions up to a maximum credit of $500, subject to a phase-out starting at $88,810 of Minnesota Adjusted Gross Income (Minnesota AGI). It might pay to contribute less each year to the 529 plan so as to get the benefit from the tax credit each year.
Whether you decide to save less over time or superfund a 529 account, this kind of investment is an important way to project family values towards higher education for your children or grandchildren.
Here are a few other issues to consider about 529 Plans:
Following the January 2020 enactment of the SECURE Act, 529 beneficiaries can pay for qualified expenses related to apprenticeships with tax-free distributions. Additionally, 529 beneficiaries can withdraw tax-free distributions up to $10,000 (lifetime) to repay student loans. The SECURE Act made both changes retroactive, so any 529 distributions for apprenticeships or student loans made after December 31, 2018, are tax-free.
As a result of the December 2022 enactment of SECURE 2.0, starting in 2024, 529 account owners can roll over up to an aggregate lifetime limit of $35,000 from a 529 plan into a Roth IRA for the benefit of the 529 plan beneficiary. The rollover is subject to the $6,500 per year rollover limit and must be in the same name as the 529 plan beneficiary, among other limitations. The 529 plan must have been in existence for at least 15 years prior to the rollover and any 529 contributions made within the last 5 years are ineligible.
Also, many families worry that saving for college will hurt their chances of receiving financial aid. But, because 529 savings plan assets are considered parental assets, they are factored into federal financial aid formulas at a maximum rate of about 5.6%. This means that only up to 5.6% of the 529 assets are included in the expected family contribution (EFC) that is calculated during the federal financial aid process. That’s far lower than the potential 20% rate that is assessed on student assets, such as assets in an UGMA/UTMA (custodial) account.
Please let us know if we can answer any questions.