One of the predominant discussions we engage in with our clients revolves around education planning. Traditionally, our clients opt to contribute annually or monthly to a 529 college savings plan, steadily building an account to cover higher education costs. While this approach is the most common, “superfunding” a 529 plan presents an exciting alternative. This strategy is attractive for those who can make larger lump sum contributions or have parents/grandparents who would like to contribute to the child’s college education in an efficient way that helps eliminate future estate and gift taxes.
What is 529 Superfunding?
529 superfunding is a strategy when you make a lump sum contribution to a 529 plan and take advantage of the five year gift tax averaging rule. This strategy allows you to fund a 529 plan while protecting a child's lifetime gift and estate tax exemption. Individuals can contribute up to $90,000 per beneficiary in 2024, which is spread out over five years. The annual gift tax exclusion is currently $18,000 per year. This means any person can give up to $18,000 to any other person without having to track the amount of the gift made. Married couples can give up to $36,000 per gift recipient! The annual gift tax exclusion is adjusted each year for inflation. Couples can double their contribution by each contributing $90,000 to each child for a total of $180,000 per beneficiary!
For many, contributing $90,000 at once to a 529 saving plan might seem daunting. However, the beauty of the superfunding strategy is its flexibility. You can utilize this approach for any amount you wish to contribute that exceeds $18,000. And here's the best part: it's not a one-time rule. Once your five years of contributions have been recognized, you can make another superfunding contribution, giving you the freedom to plan your contributions according to your financial situation.
It's important to note that any 529 plan contributions exceeding $18,000 for each of the five years need to be reported. This is done by filing the IRS Form 709 at tax time. While there are no tax consequences to you or the person receiving the gift, the IRS does require you to keep track of these special contribution amounts.
What are the advantages of 529 Superfunding?
Two significant advantages are offered to families with the means to superfund a 529 plan.
Compounding: Typically, investing a lump can lead to superior returns over dollar cost averaging. Vanguard published this brief article testing the theory that lump sum investing tends to outperform systematic contributions.Taking this approach does not ever guarantee a better outcome. Especially in the case of 529 investing, the investment strategy is typically focused on higher growth investments for the beneficiary when they are at a young age (when the lump sum would be contributed) and gets more conservative when the child gets closer to college age. If you like the odds of allowing your contribution to have the ability to compound for longer, then superfunding is a strategy worth discussing.
Family Estate Gift Planning: The most apparent reason to superfund a 529 plan is for gift and estate tax planning. This is an intelligent way to make a gift and remove money from your estate without having to utilize any of your lifetime gift exemptions. For those with significant accumulated assets, consider the following example. Two grandparents have five grandchildren and would like to pay for their college education. Grandma and Grandpa can set up a 529 account for each grandchild (even if they already have one established by someone else) and add $180,000 to each grandchild's 529 savings plan. They have immediately removed $900,000 from their estate in a single day without using any of their lifetime gift-tax exclusion!
When to Consider 529 Superfunding
Windfall Event: If you experience a windfall event or are holding excess spare cash, using this strategy could be a savvy financial move. Whether this is an inheritance, a sale of a business, or even seeing your RSUs perform better than anticipated, all could be great reasons to target a lump sum contribution to a 529 plan to take advantage of the superfunding rules.
Behind on College Savings: Many parents don’t have the capacity to save for college until their kids are at least out of diapers! This could be because you did not have excess cash flow when your kids were younger, your income has grown rapidly, like many mid-career professionals, or college planning has not been on your radar until now. A significant lump sum contribution is a great way to play catch-up.
Private College: If you start saving for your kid's college before they start Kindergarten, you are making a lot of assumptions about their education costs. The biggest unknown is how much it will cost when they are ready to attend college. Many parents target the cost of in-state college tuition as their funding goal. As your child matures, you may find out that they aspire to attend an elite private school, which is double or even triple your previous in-state target. A 529 superfunding strategy could stabilize your college plan with your higher expected costs.
Risk of Superfunding
Market Risks: While we have discussed the benefits of compounding, you may have the experience of investing at the wrong time. If you contributed your lump sum early in your child’s life, the account should have time to recover, but if you contributed when the child is closer to accessing their account, it could be an issue. Also, additional contributions are restricted for five years, potentially missing out on future investment opportunities at lower prices.
Using the 529 to Pay for Private K through 12 Education: If you live in a state that allows you to use your 529 plan to pay for private K-12 education, the superfunding is a strategy that may allow you to utilize some of the funds to help pay for these costs in addition to future college costs. Remember, though, the biggest benefit of superfunding 529s is the tax-free compounding of your investment. Taking too much out too early can cause you to come up short once it’s time to pay for college costs.
Gift Giver Passes Away: Another risk associated with superfunding occurs if the donor passes away within the five-year period. For instance, if a grandparent contributes a maximum of $90,000 and dies in the fourth year, only $72,000 is considered a completed gift. The remaining $18,000 is then reintegrated into the grandparent’s estate and could be subject to estate taxes. However, with the estate tax exemption amount at $13.6 million per individual in 2024, significant estate value is required for any taxes to be levied on the remaining superfund amount. Although the exemption levels might decrease in the future, currently, they substantially mitigate the impact of such taxes.
Over Funding: Superfunding a 529 plan could create an opportunity where you have overfunded the education goals. If you contribute a full $90,000 to a 529 when a child is a newborn, compounding at a rate of 6% would leave almost $90k in their account at the end of college. Fortunately, the recent enhancements to 529 plans make this less of an issue. More recently, there have been changes to 529 plans that allow you to rollover unused funds from a 529 plan to a Roth IRA on behalf of the beneficiary. The rollover amount is limited to the Roth IRA contribution limit each year ($7,000 in 2024) up to a lifetime limit of $35,000/beneficiary. This cool feature, coupled with the ability to transfer unused 529 funds to other beneficiaries without penalty, has made overfunding less of a risk than it was in previous years.
Bottom Line
Superfunding is not a strategy for everyone, but it is worth reviewing to see how it could factor into your estate and financial plan. Superfunding at the maximum level is likely reserved for special situations, but lower amounts above the $18,000 gift tax limit could have a place in many mid-career professionals' financial plans.
