When Progeny BITA was a mewling babe, bawling and puking, peeing, cooing and spitting, we took one look at her and just knew she was college material. We did a bit of research, asked our friends for advice and eventually toodled off to good ‘ol Vanguard and opened a 529 college savings account for her. A quick recap of the benefits of a 529 are in order:
- It is a savings plan for college. No, it cannot be used to fund expensive fancy-pants private kindergartens.
- Savings are not deductible for federal purposes, but there may be state tax benefits to be had. My state of CA has none. If your state does offer some tax benefit it probably makes sense to stick with a plan offered by your state. If not, you can pretty much pick any plan from any state, based on a plethora of reviews available online.
- Capital gains and dividends reinvested compound tax free.
- On withdrawal, no federal taxes are owed as long as the money is used for a qualified higher education expense (e.g. college tuition, room and board).
Since our crystal ball broke when our boisterous Husky knocked it over, we have no way of knowing what college education is going to look like when Progeny BITA turns 18. Also, for the purposes of the Free Application for Federal Student Aid (FAFSA) the 529 is considered a parental asset, so 5.64% of it would count towards Progeny BITA’s expected family contribution (EFC) if and when she applies for financial aid. So, we decided to hedge our bets by saving some money for Progeny BITA in a 529, and for the rest (hopefully there will be no rest) we could dip into our Roth/taxable accounts should the need arise. The magic number we chose as our target investment for her 529 was $56,000. Why $56,000? Because after compounding for 16 years at a decent rate of return that should cover 4 years of tuition at a public in-state school (assuming tuition prices continue to increase at their current rates). And because we are fundamentally lazy and $56,000 is nicely divisible by $14,000.
$14,000? What does that have to do with anything? I’m glad you asked. $14,000 is your annual gift-tax exclusion amount (per recipient) and gifting this amount incurs no tax. There are no IRS filing requirements and these gifts do not eat into your lifetime estate basic exclusion amount. So, we planned to get to $56,000 by contributing the allowed maximum of $14,000 per parent (so $28,000 total) per year to her 529. And then we discovered Superfunding.
What is Superfunding?
(As an aside, don’t you love all these cool financial names? superfunding, mega backdoor Roth. Who comes up with this stuff? They all sound like superheroes. Well, except the Roth. He sounds like a villain.)
Let’s do the numbers. Instead of being limited to $28,000 per year, a two parent family can go up to a whopping $140,000 ($14000 * 5 * 2) to fund a 529 in a single year. Basically you are being allowed to give a single recipient five years worth of tax-free gifts in a single year. If you have wealthy grandparents who want a tax-friendly way to divest portions of their estate, you can pile on even more.
We don’t have access to $140,000 to save for a 529 in a single year (we are selfishly funding our own early retirements as well), neither do we have access to wealthy grandparents. We did superfund a little though. We started her off with $48,000 in her 529.
Let us assume that Couple A invest a total of $70,000 in their daughter’s 529, but they do it at the rate of $14,000 a year for the first five years of her life. Couple B decides to superfund and puts in the whole $70,000 in the beginning. If we assume an annual rate of return of 5%, this is the result by the time the child is ready to go to college.
Superfunding yielded $15,298.14 more. The superfunded 529 in this example ended up nearly 10% larger than its less-than-super cousin.
How to Superfund
Fund your 529 and then file form 709 at tax time.
That really is all there is to it. A couple of things worth noting:
- If you contribute in excess of $14,000 per person (and up to $70,000) the entire amount will be considered to be ‘spread’ over the five year period. e.g. if you contribute $42,000, the amount of your gift over the next 5 years will be $8400. You don’t get to say that you want your extra gift to count as $14,000 per year for three years and zero for the two years after.
- You can contribute an ‘excess’ amount more than once in a five year period. If, like us, you can superfund a little, but not the max, this is useful. e.g. let’s say you contribute $24,000, that will count as ($24,000/5) a gift of $4800 for five years. The next year you can choose to contribute another $24,000, and you will now be using $9600 of your ‘gift exclusion) in years two-five (and back down to $4800 for year 6).
How exactly does one file a form 709?
You must submit a 709 (or maybe two, see below) when you file your taxes for the year.
Step 1: If you elect to split your contribution between yourself and your spouse then you say yes to question 12 of Part 1, and then answer the rather obvious questions 13-18.
The IRS instructions for form 709 say “A married couple may not file a joint gift tax return. However, if after reading the instructions below, you and your spouse agree to split your gifts, you should file both of your individual gift tax returns together (that is, in the same envelope) to help the IRS process the returns and to avoid correspondence from the IRS.”
So, if you split (or if you contribute > $70,000) , you will both fill one 709 each, and submit them together.
Step 2: Fill in Schedule A
You must choose option B to indicate that you want to split your gift over a period of 5 years. Remember the X we computed in the flowchart earlier? Use that to fill Part 1 (I’ve assumed here that a couple is filing and splitting the contribution).
Again, quoting the IRS “For each of the 5 years, you report in Part 1 of Schedule A one-fifth (20%) of the amount for which you made the election. In column E of Part 1 (Schedule A) list the date of the gift as the calendar year for which you are deemed to have made the gift (that is, the year of the current Form 709 you are filing). Do not list the actual year of contribution for subsequent years.”
The IRS also says “if in any of the last 4 years of the election, you did not make any other gifts that would require you to file a Form 709, you do not need to file Form 709 to report that year’s portion of the election amount.”
So, the year that you superfund you enter 1/5th the amount into Part 1, as shown above, and use the date of the year that you did the superfunding. In subsequent years, if you don’t make any more contributions you don’t have to file a 709. If you do make more contributions, or even other gifts to someone else, you will have to make an entry again for X/5, and this time you use a date in the current year, not the year in which you actually funded the 529.
Step 3: Attach an explanation
When you tick option ‘B’ above the IRS expects an attached explanation. Back to the source again, “Also attach an explanation that includes the following. The total amount contributed per individual beneficiary. The amount for which the election is being made. The name of the individual for whom the contribution was made.”
Here is some sample text that you could use:
- The donor made a contribution to a QTP (a 529 plan) in the amount of $X in the year YYYY.
- The contribution was made for ABC (Relationship to donor, address).
- Under section 529(c)(2)(B) the donor elects to treat the gift as having been made ratably over a 5-year period.
- [Optional] The gift was made jointly by the donor and the donor’s spouse and will be split equally in half.
- The election is made for $X over 5 years equals $X/5 per year, or $X/10 per person per year.
That is all there is to it. Your superfunded 529 is on its steroid filled way to fund a college education. You can sit back, relax and enjoy watching your progeny progress from drooling and spitting to talking and tantrums. Before you know it, they’ll be ready to walk out that door for good.
Do you use 529s? Have you superfunded? Maybe you don’t believe in college? Or maybe you want your kid to learn some solid life lessons by fending for themselves in college?
Disclaimer: Ugh. Do I have to really say this? I am a random person on the internet with no special expertise in 529s, IRS rules, taxation, or anything else I may have mentioned in this post. Don’t be lazy. Do your own research. And no, you don’t get to blame me for doing your taxes wrong.