“Superfund” is the federal government's program to clean up the nation's uncontrolled hazardous waste sites. But superfunding a 529 plan isn’t about waste at all. Ironically, learning about superfunding will help your children to learn.
529 plans are very useful and flexible mechanisms for saving for college. They are state-operated investment accounts that let anyone contribute funds toward your child's college education. The funds can be used for qualified educational expenses without any taxes on the withdrawals. Growth is also tax-free assuming the funds are used properly.
Contributions are limited to $14,000 per parent per year and are also subject to gift taxes. There are also lifetime limits on contributions that vary by state and by plan, although $200,000-$300,000 is a reasonable estimate. Once the overall value of the account (not just contributions, but contributions plus growth) reaches that threshold, no more contributions can be made unless the investment value drops below the limit. Funds will continue to grow – just without any fresh contributions.
With only a limited number of years to fund your child's account prior to college, you may not be able to reach the total value you need. That is why it is important to make higher levels of contributions as early as possible, to maximize the compounding effect on your account.
529 plans have a unique provision that addresses this issue – instead of making yearly maximum contributions, you can elect to contribute five years’ worth of contributions in one lump sum, and then make no more contributions until the five-year period has expired.
This is known as "superfunding" – two parents contributing five years-worth of maximum contributions can deposit a staggering $140,000 lump sum into the account while staying under the annual exclusion for gift taxes.
If you superfund your account early on, the effects of compounding are dramatic. Adam Nash of Wealthfront created a table showing the potential difference between making $140,000 worth of contributions evenly over time versus superfunding in your child's first year. Assuming a 6.5% return, regular contributions yielded $268,463 by age 18. Making a single, initial $140,000 contribution with no additions yielded $434,931 by the same age.
The obvious issue is: how many new parents have $140,000 to drop into a tax-deferred account – and if they do, shouldn't most of it go to a retirement account? Your children can get student aid, but you aren't going to find much for "retirement aid". On the other hand, your retirement fund probably has a longer time to grow compared to the college fund. You will have to decide the best use of your own limited funds.
Hence, the beauty of a 529 – anybody can contribute to the plan. For example, they are excellent vehicles for wealthy grandparents as it benefits their grandchildren while reducing their estate value. However, it is usually best that they contribute to an account in the parent's name as opposed to the child's name, because this can affect eligibility for any auxiliary student aid they may require. Check individual plans for restrictions and ramifications.
Tax ramifications depend on the plan that you have chosen and the state you live in. Even though 529's are state-operated programs, you are not limited to the 529 in the state you live in, or where the expected college is located. As a result, states may offer tax incentives to keep these funds in the home state, or lure investors from other states. Check through the plans thoroughly, and consult a tax professional if you need assistance understanding how you will be affected.
Even if you cannot fund to the maximum, the principle of superfunding is useful – contribute as much as you can as early as you can, and let the magic of compounding help to fund your child's education.