Should You Superfund Your Child's 529 Plan?

(Forbes) The growing costs of higher education have made it considerably more difficult for kids to “pay their way” through school. After all, College Board figures peg the annual cost of tuition and fees at four-year, public in-state schools at $10,230 for the 2018-2019 school year, and the yearly price tag balloons to $21,370 when you add in room and board.

That means we’re at nearly six figures for four years at a public, four-year institution, and of course prices go up considerably from there for private institutions and elite universities.

With these depressing figures in mind, it’s no wonder more and more parents are looking for ways to help and stumbling upon the benefits of 529 plans. With a 529 plan, parents can contribute money that can grow tax-free until their children are ready to use the account funds for higher education. And when money is withdrawn to pay for qualified higher education expenses such as tuition, fees, books, and room and board, no income taxes need to be paid on amounts taken out.

Some parents who have considerable means can even consider using current tax laws to “superfund” a 529 account. According to San Diego financial planner Taylor Schulte “superfunding” a 529 college savings account allows you to make five years of contributions at one time while still qualifying for the annual gift tax exclusion.

“For example, in 2019, the annual gift tax exclusion is $15,000 per individual,” he says.

With that in mind, an individual could make a lump-sum contribution of $75,000 today ($15,000 x 5) and, provided it's reported correctly on their tax return, avoid having it count towards their lifetime estate and gift tax exemption.

The Benefits Of Superfunding A 529 Plan

Since money in a 529 account can be invested for optimal growth, superfunding has the potential to help a child’s college savings grow at a much faster rate.

“Like retirement accounts, the quicker you can get money into a 529 the better,” says Schulte. “The money grows tax-deferred which makes it a powerful savings and investment vehicle, especially when you have ten or more years to let it compound.”

Imagine for a moment you have the means to superfund your child’s account with $75,000 in cash the moment they’re born. If you made no more contributions and the account earned 6% when compounded annually for 18 years, your child would approach their college years with $214,075.44 in their 529 account.

If you saved up the same amount the slow way, on the other hand, your earnings wouldn’t be nearly as high. Let’s imagine you deposited $4,167 into a 529 account the moment your child was born and deposited $4,167 each year for the next 17 years. If you achieved the same 6% return during that time, your child would approach college age with $128,783.85 saved for higher education expenses.

Now, that is the power of compound interest — a power you can harness at a faster rate when you are able to superfund a 529 account.

What To Watch Out For

Ryan Inman, a financial planner for physicians, says that, while superfunding can make sense, there are some pitfalls to be aware of. For example, there are a limited number of people that can afford setting aside such large amounts of money, he says.

If you must sacrifice your retirement savings or other goals to set aside so much money for college upfront, then you can’t really afford it. For the most part, you should only consider this strategy if you absolutely have the money to stash away without harming your other goals.

There’s also the chance your child won’t even go to college, which is hard to predict when the university years are ten years or more away. If you have to take the money out for any reason other than covering qualified higher education expenses, keep in mind that you or your beneficiary will have to claim the money withdrawn as taxable income (and pay income taxes on it) and pay a 10% federal tax penalty on the earnings portion of the money taken out.

One final pitfall to be aware of is what you may be giving up in terms of state tax benefits. While most states don’t offer overly generous benefits for residents who contribute money to 529 plans, this isn’t always the case. In the state of Indiana, for example, you get a 20% state tax credit on the first $5,000 you contribute to a 529 plan each year. This means that, if you cap this benefit out and contribute at least $5,000 each calendar year, you get $1,000 back annually from the state.

If you choose to superfund your account instead, you won’t be able to maximize this benefit.

Is Superfunding A 529 Account Right For You?

At the end of the day, only you can decide whether superfunding your child’s 529 plan is a good idea. However, some consumers really are perfect for this strategy, usually because they are more financially secure than most.

Superfunding makes even more sense if you are someone who already knows they want to pay for their child’s higher education, says Schulte.

“If you have a young child, you know you want to earmark the money for higher education, and you have the ability to make five years of contributions all at once without jeopardizing your own financial plan, superfunding a 529 could be a smart financial move,” he says.

Just make sure you aren’t sacrificing your own financial health to save for college — especially when you plan to deposit large sums of money into a 529 account that cannot be easily liquidated. Remember that a lot can happen with your own finances over the decade or longer you may have until your children reach college age, and you may find you desperately need that money later.

As Schulte says, superfunding is really only for those who can 100% afford it no matter what happens. If this doesn’t describe your situation, you are likely better off saving money slowly over time. Helping your children pay for school may seem like the right thing to do, but you’re only helping them if you’re not putting your own finances in peril along the way.

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