529 college savings plans have no hard and fixed annual contribution limits, unlike IRA, HSA, 401(k), or many other US tax-deferred accounts. Rather, 529 plans are often subject to state-set overall contribution limit that you should not put in more than 4 years’ worth of expenses at the most expensive university you could spend the money on (think of a number around US$300-450k).
529 contributions and US gift taxes
Annual contributions may be subject to gift tax from the donor to the beneficiary. 529 plans contributions may be subject to US gift taxes from the donor to the beneficiary, with an annual exemption of US$15,000 in 2018, and as highlighted at the end of page 6 of the IRS form 709 instructions, 529 plans are a special case where you can front-load 5 year’s worth of contributions. That means you can put US$75,000 in a 529 plan in 2018, and spread out your US$15k/year gift tax exclusion over 5 years, during which time your original $75k grows tax-free inside the plan. This is one reason Kiplinger recommends wealthy grandparents to each max out their contributions in 2018, saving up to US$150k per couple.
Clearly, student with several relatives each willing to put US$75,000 in their 529 plan this year should have no worries about saving enough for college, as the primary use of 529 plans in this case is tax savings.
Can I save too much in a 529 plan?
Given the high limits of 529 plans, one might ask whether they might serve as a better tax-deferred savings vehicle than IRAs or HSAs. My short answer is that you should only save as much across all 529 plans as you could reasonably expect to spend on all your potential beneficiaries’ qualified higher education expenses. Two safeties here are 1.) if your beneficiary gets a scholarship, you can withdraw from your 529 a dollar amount equal to the scholarship without penalty, and 2.) you can transfer the 529 from one beneficiary to another beneficiary in the family who might still use the money (say a sibling or cousin). #2 might get creative types thinking of ways to set up a multi-generation 529 fund, though there you should be careful of generation-skipping taxes.
So as a rule, I say it’s best to stop contributing to 529 plans once the balance in the accounts is enough to pay all the educational bills of all your current, living, intended beneficiaries, as if they were being paid this year. This rule of thumb is simpler than many 529 plan calculators, since I have found it to be a fair guideline to expect your investments will grow at roughly the same rate as tuitions increase.
A more modest state guideline: save $5,000 or $10,000/year in your 529
New york state provides a state tax deduction of $5,000/year or $10,000/year for married couples filing jointly, which I used as a guideline back when I was a NYC resident and found the deduction valuable and the amount convenient. Even though I am no longer a NYS resident or tax payer, I still think this amount is a good guideline since it is roughly inline with IRA and HSA amounts, and US$10k/year/beneficiary for 18 years invested at even a moderate rate of return can still pretty easily cover most if not all the cost of many 4-year university programs.
So how much should I save in my 529 this year?
Clearly, if you can afford the $75,000 up-front contribution and want to max out your savings from your 529 plan, look at doing that.
If you would rather commit to a more regular program of putting $3-6k/year into your child’s 529 plan, that would still provide worthwhile tax savings while putting a big dent in college fees. There is no rule that 529 accounts must be all or nothing, and of course you can combine 529 money with regular payments when it comes time to pay for school fees. Having less than full tuition in a 529 plan can also act as a hedge against the (however unlikely) situation where your child writes a billion-dollar app in high school and decides to skip college.
Of course, all of the above assumed you are a US taxpayer, and that you don’t have non-US taxpayers in the family happy to do all the college savings for the family. Those situations can be more complex and exciting, and are exactly why this article (or anything I say), should not be taken as tax advice of any kind.
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