Summary/TL;DR
529 Savings Plans, in addition to the great tax-advantages they have for saving for higher education, also have a unique rule that allows lump sum contributions made over the annual gift tax exclusion to be pro-rated over a 5-year period. This strategy is known as “superfunding” the 529. When done correctly and with the help of a qualified tax professional, this strategy can produce generations-worth of tax-free funding of higher education for your family.
Introduction
529 Saving Plans are state sponsored programs that offer tax-advantaged savings for college education. When the beneficiary of the plan goes to college, the funds may be distributed tax-free to pay for qualified educational expenses. Furthermore, all funds contributed to a 529 are forever removed from one’s taxable estate.
Due to the amazing tax and estate planning advantages of 529s, a commonly strategy pursued by wealthy families is the so-called “Dynasty 529”. This 529 is typically “superfunded” for grandchildren or great-grandchildren and will be used to pay for the college education of multiple generations.
Exactly how one “superfunds” a 529 to build a massive pool of tax-free wealth for their family, all while removing millions in future growth on the assets from one’s estate, will be the topic of today’s post.
“Superfunding” A 529
First, consider that all contributions made to a 529 are considered gifts for tax purposes. For most people with 529s, the gift tax is nothing to worry about. Those with higher net worths, however, might find that they need to pay close attention to the tax consequences of their contributions.
Fortunately for these taxpayers, 529 savings plans have a special rule that allows account holders to make a lump sum contribution and pro-rate their annual gift tax exclusion on the contribution over 5 years. This is typically done up to the maximum annual exclusion amount. In 2024, with an $18,000 annual exclusion, this would mean an individual could make a lump sum contribution of $90,000 ($180,000 for married couples) and incur no gift tax consequences as long as no additional contributions are made to the 529 for the next 5 years.
Opportunities for superfunding range from having an exceptionally high income, portfolio value, or experiencing a windfall through an inheritance, large bonus, or sale of a business or property.
If this kind of lump sum contribution is made early enough in a child’s life, the 529 will grow to an amount that’s likely to be sustained in perpetuity. This is known as a dynasty 529 because it can be used to pay for the college education of grandchildren, great-grandchildren, great-great grandchildren, and so-on with essentially no end in sight.
Generations of Wealth
Consider the example of a married couple who open 529s with a lump sum of $180,000 for each of their 3 grandchildren on the day they are born. Assuming the accounts grow at 8% annually, these 529s will be worth $719,283 on each child’s 18th birthday.
Next, let’s assume it costs each child $250,000 ($62,500/yr) for all of their higher education with no scholarships. At the end of their college career, they will have $469,927 left over in their 529. When they have children of their own who are ready to consider college, they’ll find that the 529 started by their grandparents (you) will have grown to a balance of $3,218,283 in the 25 years since they graduated! They can then use this to pay for their children’s (your great-grandchildren’s) higher education, and so-on, and so-forth.
It's easy to imagine how this cycle could repeat for multiple generations, presenting those with the means an opportunity to create a tax-free legacy fund for their family’s higher education.
Don’t Try This At Home
As is hopefully clear from the discussion so far, this is not something that you should attempt on your own. There are many nuances to this rule and the gift tax in general that I haven’t covered here for the sake of brevity.
Anytime you are making large decisions with large tax implications, you need to consult a tax professional to help you with execution and tax filing. This specific strategy can’t be properly accomplished without making a specific election on a specific IRS form when you file your taxes, and remember that it technically takes place over a 5-year window of time as well! Not only will the value of a good CPA far exceed their cost, but they will also help you remain in front of changes in the tax code that can present further opportunities of their own.
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