Should you super-fund your 529 college savings plan?

NEW YORK Mon Dec 16, 2013 8:04am EST

Graduates from Columbia University's Columbia College cheer during the university's commencement ceremony in New York, May 16, 2012. REUTERS/Keith Bedford

Graduates from Columbia University's Columbia College cheer during the university's commencement ceremony in New York, May 16, 2012.

Credit: Reuters/Keith Bedford

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NEW YORK (Reuters) - With college costs already astronomical and rising, saving for them isn't just a year-end thing. But if those prices - averaging $40,917 a year for a private four-year college or $18,391 for a state school, according to the College Board - have got you down, there are some ways to max out your savings before 2013 ends.

You can stuff a lot of money into a 529 college savings plan now and then do the same thing at the beginning of 2014 - a strategy that advisers say they are seeing many wealthy clients adopt this year. Because of the interplay of gift tax rules and generous contribution limits on these plans, affluent grandparents (or parents, but it's usually grandparents) can set aside as much as $84,000 per grandchild over the next month or so.

Contributions to 529 plans are made with after-tax money, but earnings that build up in the account are free of federal and state income taxes when funds are withdrawn for qualified education expenses. Some states sweeten the pot by offering tax deductions or credits against those contributions. In Illinois, for example, contributions of up to $10,000 a year for an individual or $20,000 for a couple filing jointly are deductible for state income tax purposes.

Federal tax rules allow annual gifts excluded from gift taxes of $14,000 per grandchild or other recipient per year, and there is a special rule for 529s that allows contributors to front-load five years worth of savings in one year. That means you can set aside $14,000 now and another $70,000 in January - for each budding scholar you've got.

Two grandparents with enough money could double that - with each putting away $84,000 per grandchild. Depending on where the child goes to school and how much the money earns within the 529 plan, you might be done with one sizeable contribution.

"Think of this as super-funding," says Michael Conrath, executive director and 529 program director at JPMorgan Asset Management, a unit of JPMorgan Chase & Co. "You are getting six years compressed into a small window. That is a strategy that more affluent families will look at" as a way to aggressively cover those college costs and save on taxes.


There's no timetable by which you have to spend down 529 funds and no required withdrawals, and that's what makes these plans a good place to do some estate planning while you're saving for college.

The super-funding strategy allows wealthy grandparents to get substantial amounts of money out of their estates, notes Mike Campbell, a tax partner in the private client services practice at tax and accounting firm BDO USA. He says he has clients taking advantage of the five-year front-loading for their kids and their grandkids. "They are thinking about it in terms of estate planning," he says.

If your child or grandchild ends up not needing all of the money you've set aside, you can change the beneficiary on the plan to another child, a cousin or yourself. Even if you needed to withdraw the funds for some other purpose, you would get most of your money and earnings back - owing a 10 percent penalty and taxes on the earnings.

There are some ramifications for financial aid. For federal, need-based aid calculations, the 529 plans owned by college students (who are dependents for tax purposes) or their parents count as assets and reduce need-based aid by a maximum of 5.64 percent of the asset's value. But money withdrawn to pay for college does not get factored into aid calculations.

The reverse is true for 529 plans held by grandma, grandpa or anyone else. Those assets won't appear on the federal financial aid application so have no impact on aid at first - but withdrawals do count against aid needs and can ding you pretty hard.

(For more details on how this works, see our previous story here)

The result, generally, is that it's better to have the plans in the name of the parents or students (assuming they are dependents), than the grandparents. Grandparents can contribute to those plans, however.


Of course, there are a limited number of people who can afford to set aside such astronomical sums. But even smaller savers can benefit by plowing money into a 529 plan now.

You could, for example, use bonus money or cash received for the holidays to fund a 529 plan before year-end, and then do a second funding in January or from a tax refund next spring.

To really see the value of 529 contributions, consider the way that earnings on those savings compound, and then compare that to the interest you might be paying on college loans if you don't save enough, suggests mutual fund giant (and 529 plan provider) T. Rowe Price Group Inc.

Covering $40,000 in college costs, for example, would require $32,000 in 529 plan contributions over that child's first 18 years or $61,000 in total payments on student loans, according to T. Rowe Price calculations.

Calculating the optimal contribution is less important than making a contribution, says Conrath: "Don't get caught up in the numbers, but do something."

(Follow us @ReutersMoney or here Editing by Linda Stern and Leslie Adler)

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Comments (1)
mrcrg wrote:
I am a college funding advisor who for the past 12 years has helped hundreds of families go through the college funding process. What I find amazing is how many people (those who benefit from selling 529′s) recommend 529′s. Since in the State of California, 529′s are in mutual funds, what happened to the mutual fund market in 2001-2002 (-47%) and again in 2007-2008 (-42%)? How long will it take parents to recover to where they started prior to 2001? If you lose 50% of something, you need a 100% gain to get back to where you were! What good is something that grows tax-free (if you use it to pay adjusted qualified education expenses(AQEE)when you can lose your principal? There are much better ways to save and accumulate for college and contribute to retirement. That method is cash value life insurance. There are no restrictions on how you can use the money, it never loses it’s cash value no matter what happens to the market and it can be used for anything else if it’s no longer needed to fund college. It is also a self-completing retirement plan if something should happen to the insured. There is always two sides to a coin and this is the other side that few parents are ever exposed to!

Dec 17, 2013 3:11pm EST  --  Report as abuse
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