Investing in a 529 can do wonders for your child’s future education expenses – especially when you know how to best maximize that investment.
If you’re not yet familiar with the ins and outs of a 529 account, you should first read An Intro to Investing in a 529 Account for Your Child. This will teach you the basics on what a 529 plan has to offer.
However, if you’re planning on saving money in a 529 account for your child and you’re looking to learn how to frontload your 529 account to get the most out of your 529 investment, you’ve come to the right place.
Let’s get started.
WHAT DOES FRONTLOADING A 529 ACCOUNT MEAN?
Frontloading is a term used to describe the placing of a larger amount of money into an investment account rather than placing smaller increments of that same amount of money into the account over a period of time.
WHY FRONTLOAD A 529 ACCOUNT?
1. Potentially Greater Investment Returns
If you can afford to do so, contributing a larger amount of money up front into a 529 account can be an intriguing option to maximize the value of a 529. This is because, much like your retirement accounts, the longer your money is invested in a 529 account the longer it can potentially grow in value.
For example, let’s say you decide to open a 529 account and you have $75,000 available to contribute.
If you contributed $75,000 into a 529 account when your child was born and you did not contribute any more money into the account, then in eighteen years your child would have $214,075 in a 529 account to use for higher education expenses, assuming the account grew at a conservative rate of 6% annually.
In comparison, if instead of contributing $75,000 all at once you decided to contribute $15,000 each year for five years and then make no further contributions for the next thirteen years, your 529 account would only grow to $180,353 assuming the same conservative 6% annual return.
In a more dramatic contrast, if you decided to contribute the $75,000 in increments of $4,166.67 each year for 18 years, your investment would only amass to $128,784 assuming the same conservative 6% annual return.
That is the potential power of compound interest over time.
2. Shorter Time for Investment Gains
If you open a 529 account when your baby is born, assuming the money is for college and your child never skips a grade in school, the 529 account will have 18 years to grow until your child will need to start using that money.
While 18 years may seem like a long time, this is much less time than the decades your retirement account will likely have to grow.
To combat this shorter time horizon, you could consider opening a 529 account even before your child is born. Since a social security number or a tax ID number of the named beneficiary is needed, you would have to list yourself as the 529 account beneficiary. Then, once your child is born, you could change the listed beneficiary to your child.
That aside, most of you are not in a financial position to begin contributing to a 529 account this early on as you are prioritizing managing student loans, purchasing long-term disability insurance, purchasing life insurance, investing in retirement accounts and purchasing a home.
Instead, frontloading a 529 account would allow you to take full advantage of each year you have until your child needs to use that money.
3. The Cost of Higher Education Continues to Rise Quickly
College Board’s recent survey found that both public and private college tuition is rapidly increasing. Specifically, tuition at public four-year institutions rose from $3,800 in 1990-1991 to $10,560 in 2020-2021, while tuition at private four-year institutions increased from $18,560 in 1990-1991 to $37,650 in 2020-2021. That’s a 177.89% increase for public four-year institutions and a 102.86% increase for private four-year institutions during that 30-year timespan.
If you’re a physical therapist and you think your child will want to follow in your footsteps, then the cost of a DPT program should also be on your radar. A survey conducted by the American Physical Therapy Association in January 2020 revealed that, from 2010-2019, the average cost to attend a public DPT program had risen by 53% while the cost to attend a private DPT program had increased by 31%.
If your child aspires for a different career requiring that still requires higher education, it is likely that the tuition for this field has also increased in price dramatically.
For example, the American Medical Student Association found that the cost to attend a public medical school had risen 427.96% during a 21-year period measured from $2,761 in 1981 to $14,577 in 2002, while the cost to attend a private medical school had gone up 245.46% from 8,962 in 1981 to $30,960 in 2002.
Additionally, the American Dental Association found a 56.45% increase in dental school tuition over just a 10-year period from $29,835 in 2004 to $46,676 in 2014.
The take home point here is that placing more money into a 529 account up front can potentially provide better returns over a shorter period of time, making frontloading a potentially good strategy for the rising cost of education.
With all of this in mind, the question that bears asking is “How much money can you frontload into your child’s 529 account?”
To answer this, you need to be aware of both state and federal laws.
HOW MUCH CAN YOU FRONTLOAD INTO A 529 ACCOUNT?
There is no hard limit to the amount that can be contributed to a 529 account enforced at the federal level. However, each state can impose a limitation.
If your account value reaches a certain threshold amount, then the state may prevent you from making further contributions. Each state determines the value of this threshold amount.
For example, Georgia’s Path2College 529 plan has a contribution limit of $235,000. In comparison, my home state of California’s Scholarshare 529 plan has a contribution limit of $529,000.
However, even if this amount is achieved, the 529 account is still allowed to continue growing in value through its investments.
Seeing as this state limitation is generally quite high and that your 529 account value can still continue to increase even after reaching this amount, this state-level limitation should not make you lose sleep at night.
The most important limiting factor to how much you can contribute to a 529 is actually not because of any firm contribution limitation law – it’s because of federal taxation.
Federal Gift Tax
While federal laws do not directly limit your contribution amount, the federal government does track if your annual contribution exceeds a pre-determined amount each year.
This pre-determined amount is known as an annual exclusion amount and it is enforced by the IRS under what is referred to as a federal gift tax. Since the IRS defines a gift as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return,” a contribution to a 529 account falls under this definition.
It is important to keep in mind that while the federal gift tax includes 529 account contributions, it also includes gifts that are not related to 529 accounts. These can include but are not limited to investment accounts and property such as a house or vehicle.
The total of these gifts for a single year is what must remain at or below the annual exclusion amount to avoid incurring the federal gift tax. However, if the only gift you provide your child is a 529 contribution, then you can contribute directly up to the annual exclusion amount while avoiding the federal gift tax.
If you do contribute more than $15,000 to a 529 account or if you and your spouse contribute more than $30,000 to a 529 account, then you will have to account for your lifetime gift and estate tax exemption.
The gift tax exclusion limit has historically been increased every three to five years:
1997-2001: $10,000 (5 years)
2002-2005: $11,000 (4 years)
2006-2008: $12,000 (3 years)
2009-2012: $13,000 (4 years)
2013-2017: $14,000 (5 years)
2018-present: $15,000 (4 years so far)
Lifetime Gift and Estate Tax Exemption
If you decide to contribute more than the annual federal gift tax annual exemption amount, $15,000 for an individual and $30,000 for a married couple, it doesn’t mean that you will pay taxes on that amount. Instead, that extra amount will just count against your lifetime gift and estate tax exemption.
The gift and estate exemption is the amount of money that you can gift, totaled throughout your entire lifetime, before you are required to pay taxes to the federal government.
Since the gift and estate tax exemption amount is quite large, currently $11.70 million for year 2021, you likely won’t be too worried about this limit. However, the federal government does need to keep track of the gifts you give throughout your lifetime. To do this, you are required to fill out IRS Form 709.
WAYS TO FRONTLOAD A 529 ACCOUNT
Since we’ve established that getting more money into a 529 account can provide greater investment gains, rather than investing the same amount in smaller installments over time, the next step is to learn how to go about doing this.
Since an individual can contribute up to $15,000 per year to a 529 account while avoiding the federal gift tax, that means the same individual would contribute a total of $75,000 ($15,000 x 5 years) over a 5-year period. Therefore, if this individual contributed $75,000 to a 529 account in the first year and then did not make any further contributions during the next four years, that would lead to an average contribution rate of $15,000 per year during that 5-year timespan.
The terms superfunding or tax averaging are both commonly used to refer to this exact strategy and, according to Cornell Law School’s interpretation of the law found on their Legal Information Institute’s website, the federal government acknowledges this approach without requiring a gift tax to be paid.
In fact, the same strategy can also be applied to a scenario where a married couple contributes $150,000 ($30,000 x 5 years) to a 529 account in the first year rather than $30,000 each year over a five-year period.
However, when using the superfunding strategy, be sure to file IRS Form 709 for each of the five years so that the IRS is aware of your intentions. Also, any amount contributed above the superfunded exemption amount will count against your lifetime estate and gift tax exemption.
1 Bonus Year + Superfunding
Want to contribute more than the superfunded federal gift tax limit of $75,000 for a contribution by an individual or $150,000 by a married couple?
If you started off by contributing either of these superfunded amounts, you would have to wait 5 years until you could make additional contributions if you wanted to avoid the federal gift tax. Instead, though, you could make a contribution one year up to the annual federal gift tax annual exemption amount and then the following year superfund the 529 account.
In other words, as described on Utah’s My529 website, you could contribute up to the annual individual federal gift tax annual exemption amount of $15,000 during the first year and then contribute the superfunded 5-year maximum of $75,000 the following year. This would give your 529 account a total contribution of $90,000 just from one individual contributor. This tactic can work especially well if you find yourself in the month of December one year, as you can contribute the $15,000 before that year ends and then, in January of the next year, contribute the superfunded amount of $75,000.
Contribute More Than Your Lifetime Gift and Estate Tax Exemption
If you found yourself with the ability to contribute more than a superfunded amount to your 529 account, you can still do so. The amount contributed in excess of the gift tax exclusion amount would just count against your lifetime gift and estate tax exemption.
WHERE TO GET MONEY FOR SUPERFUNDING
If you find it difficult to come up with any money, let alone an individual contributor’s superfund amount of $75,000, to contribute to your child’s 529 account, you’re likely not alone.
Below are a few potential sources of money that can help with superfunding your 529 account.
Superfund the 529 Account Using Your Salary
Unfortunately, the same survey by the American Physical Therapy Association that was referenced earlier also reviewed the wage and salary data sourced from the 2019 Bureau of Labor Statistics and found that the nationwide average salary of a physical therapist has only increased by 10% during the years 2010-2019. Sadly, this was noted to be less than 17.2%, which was the rate of inflation during that same timespan.
Therefore, making ends meet should be your first priority – and this includes funding your retirement accounts.
To assist with this, every allied health professional should pick up a side gig to increase income. My favorite, most lucrative side hustle has been working prn home health. If this is of interest to you, then be sure to read my tutorial on Getting Started Working PRN Home Health Physical/Occupational Therapy. Afterward, you can then learn how I make as much as $8,000 per month working prn home health.
Superfund the 529 Account with Money from Other Family and Friends
Even if your income can’t quite generate enough money to superfund your child’s 529 account, that shouldn’t rule out the possibility of still being able to do so. Sometimes family and close friends want to contribute towards your child’s future education needs.
If this is the case, the same federal gift tax exclusion rules apply. In other words, a single grandparent or friend can superfund your child’s 529 account up to the $75,000 while avoiding the federal gift tax and a married grandparent can do the same up to $150,000.
A worthy question to ask is “Should a grandparent open a 529 account instead of contributing directly to the 529 account that you own?” Answering this question is more complex than might appear, so it will have to be address in a future article.
Superfund the 529 Account with Inheritance
Even if a source of money from either your funds or that of family/friends does not appear readily available, having the knowledge of what superfunding is can still come in handy in the future.
For example, if you happen to unexpectedly come into a large amount of money, using that money to superfund a 529 account can be a great move. Such a windfall can occur when a relative passes away and leaves you with an inheritance. Using that money to superfund your child’s 529 account can almost be thought of as that loved one creating a college scholarship specifically for your child.
Taking this even further, if all of the money in that superfunded 529 account does not end up being used up by your child, then the remaining amount can be passed onto other family members to fund their education expenses. Now you’ve turned that one-time inheritance into a scholarship for possibly multiple generations. What a great way to carry on the memory of the loved one who left you the inheritance.
CHALLENGES WITH SUPERFUNDING
As great as superfunding a 529 account can sound, there are potential challenges that have yet to cross your mind.
Death of the Contributor
Let’s say your child’s grandparent decided to superfund your child’s 529 account to the maximum 5-year averaged individual tax exclusion of $75,000. However, that grandparent unfortunately passes away 4 years later.
Since this one-time superfunded contribution of $75,000 is based on if you were to contribute $15,000 each year for 5 years, and the grandparent passed away during the fourth year of this 5-year period, then the last year’s $15,000 would have to be return to the grandparent’s estate and be assessed for potential lifetime and gift estate tax.
However, this $15,000 could then be counted against the grandparent’s lifetime and gift estate tax which currently sits at $11.70 million for year 2021.
Your Child Doesn’t Use All of the 529 Account’s Money
While you may have every intention in the world for your child to end up attending college, it may just not be in the cards. Another possibility is that your child does attend college, but doesn’t use up all of the money in the 529 account. In each of these potential scenarios, you may find yourself with money left over in a 529 account.
You could decide to withdraw the remaining 529 account funds and spend the money on non-qualified educational expenses. However, as covered in An Intro on Investing in a 529 Account for Your Child, doing so comes at a price.
Thankfully, you can change either the beneficiary on the 529 account from your child to another family member or roll the 529 account into another existing 529 account that has another beneficiary listed.
Possibility of Overfunding Your Child’s 529 Account
If you find yourself with too much money in a 529 account and no good way to spend it while at the same time lacking investments in other areas, then you may not have prioritized your money well.
When you contribute to a 529 account, whether superfunding or otherwise, be sure that you are not woefully neglecting other areas of financial importance such as managing student loans, purchasing long-term disability insurance, purchasing life insurance, and investing in retirement accounts.
While you can superfund up to $75,000 while avoiding the federal gift tax, superfunding a slightly smaller amount could be more realistic with your budget and still be enough to reach your desired investment goal years later.
FINAL THOUGHTS. . .
I hope you found this article helpful. If you can afford to do so, superfunding a 529 account for your child can be an incredible way to positively impact the financial state of your child and/or yourself.
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