November 2, 2017

Superfunding Your 529 College Savings Plan

By Michael Buccino, CFP^®
Vice President of Wealth Management
the Dowling Group

There is no better time to start saving for your child’s college education costs. Why? It’s expensive. The costs associated with paying for a college education have never been higher.

According to website www.CollegeBoard.org, a non-profit that works to expand access to higher education, the total cost of attending a four-year, out-of-state public school is $35,370 and a four-year private school is $45,370. These costs are expected to continue to rise 3-5% annually. Deciding how to pay for your child’s, or grandchild’s, college education can seem like a daunting and overwhelming financial obligation. Fortunately, there are options.

529 College Savings Plans (“529 Plan”) provide attractive benefits and flexibility for saving for college. A 529 Plan is a tax-advantaged savings plan designed to encourage saving for future college expenses. 529 Plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.

There are several ways 529 Plans benefit those saving for college. First and most beneficial, all investment earnings growth is federally tax free as long as distributions from the plan are used for qualified education expenses. Second, many states allow those contributing to 529 Plans to claim a tax deduction of up to $10,000 in the year their contribution was made. Third, the owner of the 529 Plan remains the owner of the account assets forever. This is different than a UTMA or UGMA custodial account where the beneficiary takes control of the account assets once they reach a certain age. Lastly, these plans are easy to manage and don’t require much maintenance. In most cases periodic contributions and investment allocations can be automated.

For savers looking to maximize the benefits of a 529 Plan, there is one additional strategy that can add significant value: 529 Plan Superfunding. 529 Plan Superfunding allows savers to contribute five years of the annual gift tax exclusion (currently $14,000), or $70,000 in 2017, in a single year without having to file a gift tax return or reducing their lifetime exemption.

The purpose of this “superfunding” strategy from the IRS’s perspective is to incentivize savers to commit more money to college. There are several benefits to this strategy. The growth of the additional $56,000 that otherwise may not have been contributed grows tax-free inside the 529 Plan reducing the income that would have otherwise been taxable to the saver had they invested the funds in a taxable brokerage account.

Additionally, if the account is held in the name of an individual other than the saver, the funds contributed to the 529 Plan are not included in the calculation of the saver’s estate value. Grandparents are also entitled to the same benefits if they would like to utilize a 529 Plan for a grandchild’s college education.

The additional contribution that 529 Plan Superfunding allows translates to a shorter time horizon necessary to feel comfortable that your college expenses are covered.

For example, let’s compare the ending value of a 529 Plan when contributing $70,000 on the first day of year one vs. contributing $70,000 over the 18 years ($3,888.89 annually) leading up to college. Assuming a 5% growth rate, the account with the initial contribution of $70,000 accumulated at the end of year 18 an account balance of $168,463 vs. the account with annual contributions of $3,888.89 with an account balance of $109,404. This is a difference of $59,059. The value of 529 Plan Superfunding can be quite significant.

If you, or someone you know, are in the process of saving for college education, a 529 Plan is a good option to consider. Talking with your tax advisor to understand which plan may be best for you and your family is always sound advice. Do not let the thought of paying for college overwhelm you. There are options you can take advantage of today to help prepare for the costs of college when your child or grandchild is ready to take that step.