Families who have large estates often look for ways to structure their assets so that they can minimize estate taxes for when they pass. I worked with one couple who were in their late 50s who had a large estate. Knowing that their estate likely had 20 years to continue growing, they were seeking a way to move money out of their estate and benefit their heirs without incurring gift taxes.
Because the couple had grandchildren, we explored funding 529 Plans for their education. Annual gifting limits in 2021 allow an individual to gift up to $15,000 per recipient without incurring a gift tax. As a married couple, both a husband and the wife may give $15,000 each. Contributions to a grandchild’s 529 Plan count as a gift.
However, the Internal Revenue Code for 529 Plans allows for “superfunding,” where an individual may contribute up to $75,000 at once to jumpstart a college savings account. The IRC allows the individual to prorate the gift as if were given over a five-year period. Since a spouse can give the same gift, a couple could fund a 529 Plan up to $150,000 at once per beneficiary without incurring a gift tax.
When doing this, it is advisable to file a gift tax return, notifying the IRS that you are using this strategy even though it uses zero of your lifetime exemption for wealth transfer. If the gifting limit were to increase within that five-year period, you would be able to gift more money up to the new limit. For example, if you and your spouse were to superfund a grandchild’s 529 plan today with $150,000, you would be unable to gift anything more to that grandchild for the next five years—inside or outside of the 529 Plan. However, if in three years, the gifting limit was increased to $17,000 a year per individual per beneficiary, each taxpayer could gift the same grandchild an additional $2,000.
In reality, an individual could gift more to the beneficiary’s 529 Plan, but only the first $75,000 per individual taxpayer is eligible for the special five-year gift-tax exclusion. Anything above and beyond would be applied to the taxpayer’s lifetime gift and estate tax exemption, thus lowering how much of the estate would pass tax free upon the taxpayer’s death.
If the grandparents individually wanted to contribute less than $75,000 but more than $15,000 to the 529 Plan, the amount is still prorated over five years. For example, if one wanted to give $40,000 to a 529 Plan, it would be applied at $8,000 a year, leaving $7,000 per year for additional gifts.
This strategy is only one option to reduce an estate. Before you superfund a 529 Plan, you must carefully consider any other gifts given to that beneficiary for the next five years. While 529 wand graduate education, you must also consider the options available should the beneficiary receive a scholarship or decide not to go to college. Funds not used for qualified education expenses may incur taxes and a 10% penalty upon withdrawal.
Before superfunding a 529 Plan, a taxpayer should consult their tax adviser and financial planner to determine if this is the best gifting strategy.