That title was a trick. I’m actually going to write about how much you should contribute to a 529 first. Lately I’ve heard versions of the same question again and again: After a year of no travel, eating out or other activities, people are sitting on extra cash that they want to direct towards college. Many are wondering what’s the maximum amount they can put in a 529. The answer– again– is “it depends.”

First off, if you’re not maxing out retirement savings, put your surplus there first. My rule of thumb is this: If you’re not maxing out retirement, you should be contributing no more than 10% of what you’re saving for retirement to college. If you want to save more for college, save more for retirement. Two qualifiers:

  • “Rule of thumb” means “way of thinking about this.” It’s not going to be universally correct and may or may not be correct for your situation. For example, if you’ve got a big pension and that’s why you’re not maxing out your 403b, it might make sense for you to save more for college.
  • “Maxing out retirement” for the purpose of this discussion means maxing out contributions to employer plans for anyone who’s eligible and an IRA for anyone who’s not. In a two-parent household where both are under 50, one has a 401k and the other doesn’t, that’s $19,500 to 401k and $6,000 to an IRA. Over 50, add $6,500 to the 401k and $1,000 to the IRA.

If you’re not there, then direct your surplus towards retirement. If you are, here is how 529 funding works. The IRS does not set a dollar limit on how much can be contributed to a 529 other than to say, “contributions on behalf of any beneficiary can’t be more than the amount necessary to provide for the qualified higher education expenses of the beneficiary. Contact the program’s trustee or administrator to determine the program’s contribution limit.” Each state decides:

  • Whether to offer a state tax benefit for contributions
  • If so, how much
  • The maximum aggregated account balance a beneficiary can have in the state’s plan

What does matter for anyone who wants to fund college aggressively is the federal gift tax exemption and the special rules for 529 contributions. The IRS considers contributions to 529s to be gifts to the beneficiary. For grandparents, this can be a great planning tool since contributing to a 529 removes the assets from the grandparents’ estate while keeping them under the donor’s control. (That’s a bigger topic than this post; contact me or your financial advisor if you want more details.)

For 2021, the annual gift tax exemption is $15,000. This means that any person can gift $15,000 to another person without filing a gift tax return. Each parent (or grandparent) gets the $15,000 annual exemption, meaning that two parents can contribute up to $30,000 per child ($15,000 per parent) without having to file a gift tax return.

529s also allow for “superfunding” or electing to spread a larger contribution over five years for gift tax purposes. Superfunding allows an individual to contribute up to $75,000 to a single beneficiary’s 529 in a single year and elect to treat it as though it had been made in equal installments over 5 years. This can be a great strategy for grandparents trying to reduce their estate quickly, but it has some drawbacks for parents– besides the generally limited number of parents who have that much extra cash on hand:

  • Most states do not allow you to carry forward 529 tax benefits, so the larger contribution in a single year is likely to cost you four years of tax deductions
  • The five-year rule means that regardless of the amount, 20% of the gift is “counted” in each of the five years. Thus a $45,000 contribution would be treated as five years of $9,000 annual gifts, not three years of maximum ($15,000) gifts.

Superfunding your 529 needs to be considered in the context of your family’s full financial situation: do you have adequate emergency and retirement savings? If so, what state tax benefits might you forego by making a larger current-year 529 contribution? I’d suggest that for the vast majority of parents, the numbers don’t pencil out; for grandparents it could be a different story.