Superfunding a 529
A contribution to your child’s 529 account is, according to the IRS, a gift to your child. This means that it’s subject to annual gift limits: any individual can gift another individual $15,000 in 2021 without reporting it anywhere or paying any taxes on it. In 2022, the limit– or exclusion amount– goes up to $16,000.
Anyone who contributes more than $15,000 to a single beneficiary’s 529 is “superfunding” the 529, and special rules come into play. Very few parents contribute anywhere close to $15,000 each to their child’s 529; indeed, the average 529 account balance is just over $25,000 total. Plus, the $15,000 limit is per giver, per recipient, so two parents could contribute $30,000 to their child’s 529 this year.
Superfunding allows you to treat a contribution in excess of the annual gift limit as being made ratably over five years. As a result, the contributor does not need to file a gift tax return and does not need to subtract the contribution from their lifetime gift and estate tax exemption.
What’s the benefit of superfunding? It’s most beneficial for grandparents who want to remove assets from their estate. Superfunding a 529 allows each grandparent to contribute $75,000 per grandchild in a single year. For a couple trying to reduce assets, superfunding 529s for six grandchildren would remove $900,000 from their estate.
Superfunding has drawbacks that make it a less desirable strategy for parents. First and foremost is the logical drawback: if you superfund your child’s 529 at birth, that will likely grow to over $500,000 by the time they are 18. Even with rampant college tuition inflation, that is likely more than they need, and overfunding a 529 to that degree doesn’t offer a lot of benefits.
Second, because superfunding limits or eliminates contributions in the subsequent four years, you may be giving up tax benefits by superfunding. Very few states allow for deductions for contributions up to $150,000.
Third, if you superfund a lesser amount than the $75,000 maximum, you still have to apply that equally over five years. For example, if you contributed $20,000 this year, that is treated as $4,000 each year from 2021-2025. This means that in any subsequent year, the maximum contribution you could make is $16,000 (the annual gift exclusion amount in 2022) minus $4,000 = $12,000.
Finally, there are clawback provisions that come into play if the superfunder dies before Jan. 1 of the fifth year following the superfunding contribution.
Superfunding is more likely to be done by grandparents because it can be a beneficial estate planning strategy. Grandparents considering this should consult with their financial and tax advisors on the pros and cons of this strategy, and also with the parents of the child to whom they intend to make this gift.
A simpler strategy for parents who have funds in excess of the gift limit that they’d like to contribute is to limit current year contributions to $15,000 per parent and save the rest for a contribution after Jan. 1.
See How Much to Save for more info.
