Superfunding 529 Plans to Reduce Your Estate and Taxes

529 plans are tax-advantaged plans similar to Roth IRAs; funded with after-tax dollars, tax-free growth, and tax and penalty-free withdrawals if used for qualified educational expenses. Superfunding these 529 plans can also be used as an inexpensive and simple estate planning tool.

Reduce your estate size

Grandparents who want to help pay for college tuition and other educational costs can utilize the annual gift exclusion to fund 529 plans. Contributions to a 529 plan for the benefit of a child, grandchild or other family member are considered gifts and the money (and future growth) is removed from their taxable estate.

A grandparent can contribute up to the annual gift exclusion amount each year, or superfund the account. For 2024 the annual exclusion is $18k per individual and $36k for married couples.  A strategy known as ‘superfunding’ allows people to contribute up to 5 years’ worth of the annual gift exclusion all in one year.  This means a beneficiary’s account can be superfunded up to $90k (5 x $18k) or $180k (5 x $36k) in 2024.  The contributions will count toward the annual gift tax exclusion for five years and a gift tax return will not need to be filed.   

Furthermore, there isn’t a limit to the number of beneficiaries someone can give to.  The annual exclusion is per Donee (529 plan beneficiary) per year.

Those looking to remove additional assets from their estate can both superfund 529s and pay tuition directly to the school. Tuition payments do not count towards the annual exclusion and are not considered a gift.

Remove assets from the estate without losing control

While contributions to a 529 plan are considered gifts to the account’s beneficiary, the owner of the account maintains control of the investment selections, distributions, and can change the account’s beneficiary.  The account owner can be the grandparent, or they can contribute to an account owned by someone else, such as their adult children.  

Because withdrawals from the 529 account are handled by the account owner, the owner retains control over the assets and can ensure money is used as intended.

What counts as a qualified withdrawal has expanded in recent years to include not just college tuition and room and board, but also K-12 tuition, student loan repayments, computer equipment, and even groceries.  

What about unused 529 plan money?

Up to $35k held in a 529 plan account can roll into a Roth IRA held in the 529 account beneficiary’s name once the account has been open for at least 15 years.  This can help jumpstart a young adult’s retirement savings, and assets held in the Roth IRA will continue to grow tax-free.

If more than $35k goes unused, the money can be left in the 529 plan to continue growing tax-free. Options for using the money include changing the account beneficiary to another family member who can use the funds down the road, or the account will pass to the current beneficiary at death unless a successor owner is named.

What are the benefits of reducing the size of your estate during your lifetime?

At death, assets above the lifetime exemption amount are subject to an estate tax. Currently, the exemption is $13.6M per person, however, it is scheduled to cut in half to ~$7M per person starting after 2025, when the TCJA expires.   For married people, the unused exemption is portable to the surviving spouse.

While the exemption amount is high, the value of a gross estate at death can add up fast. It includes not only investment accounts but also assets such as real estate, trusts, annuities and any business interests. The fair market value is used to determine the value of an estate, not the cost basis.  Taxable gifts (those made during life over the annual exclusion amount) are added to the value of the estate.

For example, a gross estate that is $1 million over the lifetime exemption will owe $346k in federal tax (based on the 18% to 40% progressive tax rates).  Any amount above $1 million is taxed at 40%. In addition, some states have their estate taxes and may even impose an inheritance tax.

Gifting to heirs now can reduce the estate down the road and avoid the additional taxation. For example, $180k gifted in 2024 to a 529 plan could be worth $430k in 15 years, assuming a 6% annual return.  That is $300k in tax-free growth, and $430k not included in the taxable estate.

Additional Tax Benefits

Even for those who won’t be affected by the estate tax at death, funding a 529 plan offers an opportunity to create a tax-free portfolio that will benefit heirs during the Donor’s lifetime.  Moving money from taxable sources, such as a brokerage or savings account, to a 529 plan allows the money to begin to grow tax-free.

Some states allow a state income tax deduction for contributions made to a 529 plan.  Ohio, for example, allows up to $4k per beneficiary to be deducted from state taxable income.

Those who no longer have earned income or make too much to contribute to a Roth IRA don’t have this limitation with a 529. Additionally, there isn’t an annual contribution limit to 529 accounts. There is an aggregate lifetime limit, which varies by state. The Ohio 529 limit is currently at $541,000.

Unlike Roth IRAs, account beneficiaries of 529 plans don’t have to distribute the balance within 10 years. This presents an opportunity to stretch tax-free growth to multiple generations.  Remember a 529 account can change beneficiaries. If the original beneficiary does not use the money in the 529 plan, a new beneficiary, that is related to the original beneficiary, can be named.

529 Plans Avoid the Kiddie Tax

Those aged 18 and under as well as full-time students under age 24 are subject to the Kiddie Tax for any taxable accounts or assets held in their name. This includes accounts such as UTMA and youth brokerage accounts that may be used to pay for college. Any unearned income above $2,500 is taxed at the parent’s tax rate.  

While it may be tempting to gift appreciated stock to a minor or college student, the recipient also receives the donor’s cost basis and will pay tax on the gain, either at their parent’s tax rate or their own once they are out of college. Appreciated stock is better to inherit at death when the beneficiary receives a step-up in basis.  However, those wanting to gift appreciated assets to reduce their estate may want to look for tax loss harvesting opportunities, and fund a 529 plan with cash raised from the asset sale.

Bottom Line

529 accounts offer a way to pass money on to heirs that will grow tax-free, reduce a taxable estate without using the lifetime exemption, and won’t be subject to the 10-year distribution rules a Roth IRA has, all while allowing the donor control of the assets during their lifetime.