529 Plans are savings plans with tax advantages designed to encourage saving for future education costs.
At a legal level, these plans are sponsored by states, state agencies, or educational institutions to help ensure that higher education is more affordable.
Early education planning helps ensure security and stability for our children.
As physicians who understand the importance of this, 529 savings plans are the best option.
In this detailed guide, we’ll discuss the ins and outs of educational planning while highlighting the concept of a Superfund 529.
You’ll also learn more about the rules of this plan and how to properly apply them.
Key Takeaways
- Superfunding requires making a significant contribution to a 529 plan. The strategy helps secure the education of our kids or grandkids while enjoying tax-free growth.
- Contributions to a superfund 529 plan are limited to a minimum of $15k, or $30k for couples, and a maximum of $75k, or $150k for couples.
- To superfund a 529, you’re entitled to a gift tax exclusion.
- Only qualified expenses are subject to tax-free withdrawals.
Table of Contents
What Does It Mean to Superfund a 529
Superfunding a 529 plan is an investment strategy that involves making large lump-sum contributions to a 529 plan to benefit from IRS tax-exclusion rules.
For instance, a grandparent with significant assets may want to ensure that their grandchild’s education is fully funded by superfunding a 529 with a $75,000 contribution.
This reduces their taxable estate and provides a significant amount of money that can grow tax-free over the years.
While it sounds attractive in general, there are certain situations where superfunding is most beneficial.
- Early Start with Investment Compounding: Contributing a large lump sum early in the beneficiary’s life gives the investment more time to compound free of tax. By the time the beneficiary reaches college age, the value of their account would be significantly higher.
- Estate Planning: High-net-worth individuals have substantial taxable assets. However, superfunding a significant portion of these assets into a 529 plan helps them remove these assets from their estate and reduce future estate tax liabilities.
- Beneficiary with High Education Costs: Sometimes, you might want your beneficiary to attend expensive private schools or pursue advanced degrees. Superfunding, in this case, can help ensure there are sufficient funds to cover for these.
How to Superfund a 529 Plan [Step-by-Step]
If you intend to superfund a 529, here are a few steps you can follow. These would also ensure you avoid mistakes that will lead to penalties.
Step One: Learn More About 529 Plans
Before making any investment decision, it’s only right that you do proper research.
One best way to do so is to consult with a reliable financial advisor. They’ll help familiarize you with the various 529 plans and contribution limits.
Step Two: Choose a 529 Plan
Compare different 529 plans to find which is best for your needs. Consider factors like state tax benefits, investment options, and fees.
Once you’ve chosen a plan, follow its procedures to open a new 529 account.
This may require you to provide personal information for both the account owner and beneficiary.
Step Three: Understand the Rules of Superfunding
It’s necessary to understand the rules of superfunding, such as what qualifies for withdrawals and what doesn’t.
Also, learning about the exact rules of tax reporting for these kinds of plans can help you avoid penalties.
Step Four: Contribute an Amount Within the Limit
Superfund 529 plans are capped at $75,000 per individual and $150,000 for married couples, with the lowest contribution at $15,000.
Determine a contribution within this range that would be suitable for you.
Some people would prefer to do a one-time lump sum contribution spanning 5 years, which gives room for more investment returns.
You can try this if you’re financially capable, or otherwise stick with the normal contribution.
Step Five: Monitor the Investment
Superfunding a 529 plan is a vital decision; however, monitoring your investment plan is also important.
Several plans offer age-based portfolios that adjust automatically as the beneficiary approaches college age, while others may remain constant.
Regardless of which plan you choose, periodically review the account to ensure it’s on track to meet your goals.
You can adjust the investments as needed based on performance and changing market conditions.
Rules to Understand Before Superfunding a 529
Annual Gift Tax Exclusion
The IRS allows individuals to gift up to $15,000 per year and per beneficiary without incurring gift taxes.
For married couples, this amount doubles to $30,000 per beneficiary.
There’s also a condition in superfunding that allows you to treat a one-time contribution as if it were made over five years.
This means you can contribute up to $75,000 (or $150k for couples) to a single beneficiary’s 529 plan in one year without triggering the federal gift tax.
Control and Transfer Rights
The account owner retains control over the 529 plan, even after superfunding, allowing for changes to the beneficiary or the allocation of investments.
Also, if the original beneficiary doesn’t use all the funds, the account owner can transfer the balance to another eligible family member without penalty.
Qualified Education Expenses
To withdraw from a 529 plan, the expense has to be a qualified one.
This means it must be used for any of the following educational purposes, including tuition, fees, books, supplies, and equipment needed for enrollment or attendance.
Other cases include:
- Room and Board: These costs are only qualified expenses if the student is enrolled at least half-time.
- K-12 tuition: An allowed sum of up to $10,000 per year for K-12 expenses.
Non-qualified withdrawals, on the other hand, are subject to income tax on earnings and a 10% penalty.
Impact on Financial Aid
529 plans can either be parent-owned or grandparent-owned, each option having different rules for assessment.
Parent-owned 529 plans are considered parental assets and are assessed at a maximum rate of 5.64% when determining the Expected Family Contribution (EFC) for federal financial aid (FAFSA).
On the other hand, assets in a grandparent-owned 529 plan are not reported on the FAFSA.
However, withdrawals for the student’s benefit may be considered as the student’s untaxed income, which can affect financial aid eligibility.
Estate Planning Considerations
Once a contribution is made from an estate, it is immediately removed, making it beneficial for estate tax exemption purposes.
However, if the account owner or the designated beneficiary dies within the five-year period, a prorated portion of the contribution may revert to the estate, potentially subjecting it to estate taxes.
Investment Options
529 portfolios can be based on investment structures.
For instance, an age-based portfolio can automatically allocate assets based on the beneficiary’s age.
There are also static investment options that allow for fixed asset allocation.
Some other options enable you to change the investment options within your 529 plan twice per calendar year.
Learn More with Physicians Thrive
As physicians, we understand the need for quality education and why superfunding a 529 plan can be a desirable investment for our children.
However, as with every investment plan, taking the right steps is vital.
This is why consulting with experienced physicians and financial advisors like Physicians Thrive is a good way to go. Contact us today to learn more.
