National 529 Day is coming up! Celebrate on May 29 by making a gift to a child or grandchild’s 529 Qualified Tuition Savings Plan (formerly called 529 College Savings Plans). These savings vehicles are available through government-sponsored programs in nearly all states and the District of Columbia. Most 529 plans offer a range of investment options, including age-based portfolios, and stock & bond mutual funds. The initial advantage – contribute after tax dollars to these accounts and they grow tax-free. The funds are tax-free upon withdrawal when used for eligible education-related costs at accredited institutions. The 2017 tax act expanded 529 plans from college-related expenses to fund up to $10,000 in tuition for grades K-12 per beneficiary per year.
Some states offer a deduction on state tax returns, and several, including Arizona, Minnesota, and Pennsylvania, offer tax benefits to residents contributing to any 529 plans, whether in-state or out-of-state. In Massachusetts, an individual can claim a state income tax deduction up to $1,000 for single filer and up to $2,000 for a joint return.
While these plans do not have annual contribution limits, contributions to a 529 plan are considered gifts for federal tax purposes, and in 2022 up to $16,000 per donor ($15,000 in 2021), per beneficiary qualifies for the annual gift tax exclusion. This means parents, relatives and friends can give up to $16,000 each to a child’s 529 plan and remain within the gifting limit.
529 plans offer the ability to give larger sums in a single year, using 5-year Gift Tax Averaging, which allows individuals to contribute up to 5 times as much money in a lump sum as the annual gift tax exclusion in a single year. The lump sum contribution will use all or part of the annual gift tax exclusion for the beneficiary over the 5-year period. This means you can contribute up to $80,000 in one year and use the exclusion across the 5-year period but cannot make additional gifts under the annual exclusion to the same beneficiary for 5 years.
A great benefit of this program is that the asset leaves your estate but doesn’t leave your control. This allows you to reduce your estate tax exposure through gifting, without irrevocably giving away your assets.
There are several strategies that may allow you to contribute even more money to each child’s plan without paying gift taxes or using up part of their lifetime gift tax exclusion.
6-Year Gift Tax Averaging
This allows you to give the equivalent of six years’ contributions at once through careful timing. To do this, give one year’s contributions up to the annual gift tax exclusion by December 31 of one year, followed by a lump sum contribution utilizing 5-year gift averaging on or before January 1 of the following year. This allows you to give an extra $16,000 per beneficiary.
Give to the Parents
If you give money to the parents, up to the $16,000 gift tax exclusion amount, they can then contribute these funds to a child’s 529 college savings plan. This allows you to give an additional $16,000 per year to the family.
Give the Gap
A lump sum contribution greater than the annual gift tax exclusion is treated as occurring ratably over the 5-year period starting with the current calendar year. This means that if the gift tax exclusion increases over the 5-year gift tax averaging period, you can give a supplemental contribution equal to the increase in the gift tax exclusion.
Please speak with me or a member of your JDJ team to learn if contributing to a 529 plan makes sense for your family.