With the cost of higher education rising exponentially and the growing importance of an advanced degree, more and more students are taking the plunge and heading to college. Increasingly, parents, grandparents and other guardians have continued to help defray higher education costs. And one of the best places to do that saving has been 529 Plans.
Thanks to their myriad of tax benefits, more than $350 billion in assets sit in the plans as of last year. But saving money in a 529 plan can still be a bit tricky.
And that’s because as state-sponsored savings vehicles, there are several quirks involving lifetime caps and maximum annual deposits. However, once you understand the basics behind contribution limits for your plan, contributing to a 529 plan is easy and makes a ton of sense for college savers.
Click here to learn more about the 529 savings plan.
Federal Considerations
Figuring out the contributions limits for retirement plans is pretty easy. The Internal Revenue Service (IRS) sets the annual limit for 401(k)s, IRAs and similar plans each year and uses a formula for additional increases. As Federally sponsored vehicles, these limits apply to everyone. However, the math gets a bit tricky for 529 plans because both the states and the Federal government play in the same sandbox when it comes to college savings.
In terms of actual contributions and how much you can place into a plan, the IRS doesn’t set a limit like a 401(k). But what it does do is provide guidelines on the so-called gift tax for college savings. In a nutshell, you can’t give someone a large sum of money or assets without it triggering taxes/counting as income. This extends to college savings as well.
For 529 plans, individual savers can make deposits up to $15,000 – or up to $30,000 for married couples filing jointly – to qualify for the annual gift tax exclusion. So, each year, a married couple could provide their child with a $30,000 into a 529 plan and not have to deal with gift taxes.
Given that 529 plans are meant for education, the IRS has expanded rules allowing for larger one-time gifts, which is called “front-loading” or “super funding” a 529 plan with five years’ worth of contributions at once. Individuals may contribute as much as $75,000 to a 529 plan in 2020. The number jumps to $150,000 for married couples. Savers going this route must fill out a Form 709 each year for five years to report the front-loaded contribution.
Savers can certainly place more than these amounts in a 529 plan. However, any contributions will be in excess of the gift tax exclusion and be subjected to taxes/fees.
States Make the Rules
Where the states come into play is in terms of the annual and total contribution to a 529 plan. Because individual states sponsor and set the rules on 529 plans, the federal government defers contribution limits to these authorities – with a few caveats.
Check out our state plans section here to learn more about the rules and regulations pertaining to each U.S. state.
The caveat is that under Federal rules, a plan must not “accept contributions in excess of the anticipated cost of a beneficiaries total qualified education expenses for five years at the costliest college under the plan.” While that may seem like a mouthful, what we’re looking at is tuition, room & board, lab fees and required equipment at the most expensive school in the state multiplied by five. However, some states have challenged these rules and argued that it should be for the most expensive college in the nation. Going to college in California is more expensive than, say, Mississippi. Some states have argued that it puts their plans at an unfair disadvantage versus others. And other states have included graduate school education in their formulas, as well, given that you can use the plans for paying for advanced degrees. As a result, a few states have begun tweaking their formulas and boosting contribution limits.
With this, most states have limits of $300,000 and up. For example, New York will allow you to contribute $520,000, while Alabama sets the limit at $400,000. Historically, most states will raise their limits each year to keep up with rising college costs.
The key thing to remember is that this is the maximum you can contribute per beneficiary. Once you deposit this amount into a state’s plan, you can’t contribute anymore. The account can certainly grow through investment gains and interest, but there can not be any more money placed in the plan.
Secondly, some states allow for income tax breaks on contributions. However, any amounts above this cap wouldn’t receive a tax break. For example, New York will allow you to deduct $5,000 per year off of state taxes for a 529 plan. But contributing more than that won’t add to this deduction. This is something to think about when deciding how to place money into a 529 plan.
You can check the current maximum contributions for various states here.
The Bottom Line
529 plans are wonderful vehicles for saving for college and other higher education expenses. However, there are a few tricks when it comes to contributing money to them. Both the Federal and state governments have different rules regarding deposits into these plans. It’s important to know the rules for your plan, so you don’t run afoul of gift taxes and other fees.
Be sure to check the 529 Insights section here to learn more about 529 plans.
