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Robert Bloink and William H. Byrnes

Financial Planning > College Planning > 529 Plans

Should Your Clients ‘Superfund’ Their 529 Plans?

By Robert Bloink By William H. Byrnes

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What You Need to Know

  • Section 529 plans allow taxpayers to pay for college on a tax-preferred basis.
  • Clients interested in funding 529 plans for children and grandchildren should be advised about the smartest way to fund these plans.
  • 529 plans have become more flexible in recent years, meaning that clients should understand all of their options.

Section 529 education savings plans are a powerful college savings tool. These plans allow taxpayers to pay for college on a tax-preferred basis. With the new year fast approaching, clients who are interested in funding 529 plans for children and grandchildren should be advised about the smartest way to fund these plans, including a superfunding technique that allows the client to pre-fund the account in a single year.

Generally speaking, the sooner a 529 savings plan is funded, the longer the account value has to grow tax-free. On the other hand, clients are typically concerned with the risk that their children or grandchildren won’t attend college, meaning that they could be taxed on the account withdrawals in the future — and could also incur a 10% penalty on funds withdrawn for nonqualified purposes.

Section 529 plans have become more flexible in recent years, meaning that clients should understand all of their options when evaluating the superfunding strategy.

Section 529 Savings Plans: The Basics

IRC Section 529 college savings plans are funded with after-tax dollars that are permitted to grow on a tax-free basis (much like a Roth IRA), so that distributions from the account are not taxed when received so long as they are used to pay for qualified higher education expenses.

Contributions to a Section 529 plan are limited to the annual gift tax exclusion amount — meaning that clients can contribute up to $16,000 per year in 2022 (increasing to $17,000 per year in 2023). If contributions exceed that amount with respect to any single individual’s account, the contribution will be considered a gift that will generate gift tax liability.

However, clients also have the option of grouping their contributions for up to five years in a single year. For 2022, interested clients are able to make an $80,000 contribution in one single year rather than over a five-year period ($160,000 for married couples who agree to split gifts). That gives the account value more time to grow, especially if the client’s children are already nearing college age.

Superfunding can also be beneficial for clients who expect their estate to be above the lifetime exemption amount (currently, $12.06 million, reverting to around $5 million in 2026). Funds that are contributed to the 529 account are also removed from the client’s estate for estate tax purposes.

Is 529 Plan Superfunding Right for the Client?

A superfunding strategy will, of course, tie up more funds within the 529 account. That means it’s important for the client to evaluate the rules, understand the flexibilities associated with 529 plans and determine whether making a large lump-sum gift to the account is the right move.

Clients are permitted to fund multiple Section 529 plans for different beneficiaries without gift tax consequences, as long as the annual contribution for any particular beneficiary does not exceed the annual exclusion amount. The client is also permitted to change the original account beneficiary — for example, if one child chooses not to attend college, they could change the beneficiary to another child.

Clients should also be aware of changes that went into effect beginning in 2018 to make 529 plans more flexible. Under prior law, qualified education expenses for Section 529 plan purposes were generally limited to costs incurred to pay for post-secondary school (meaning tax-free withdrawals were limited to withdrawals to cover the costs of attending college or university).

However, the 2017 tax reform legislation expanded the reach of Section 529 plans so that clients may now use up to $10,000 in 529 plan funds per year for elementary or secondary school expenses (although it remains important to check with the plan itself to confirm that they have modified their rules to implement this new federal rule).

The new $10,000 limit for elementary and secondary school expenses applies on a per-child basis, so that even if the child is beneficiary of multiple Section 529 plans, he or she may receive only a total of $10,000 in pretax distributions annually for pre-college educational expenses.

Tax reform also modified the Section 529 plan rules to permit a tax-free rollover of 529 plan funds to an ABLE account with the same beneficiary, or a beneficiary who is a family member. ABLE accounts are similar to Section 529 plans, but are designed to provide tax-free distributions to cover expenses of individuals with various disabilities. Funds that are rolled over count against the $16,000 annual contribution limit for ABLE accounts.

Conclusion

The rules governing 529 savings plans are nuanced. For the right client, however, superfunding the account can prove to be a valuable strategy to maximize the currently high gift tax exclusion.

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Robert Bloink

William H. Byrnes

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