If you can swing it financially, it makes sense to front-load your 529 plan, also known as a “qualified tuition plan” (QTP). The purpose of a 529 plan is to pay future education costs, typically for a child or grandchild. Before passage of the Tax Cuts and Jobs Act of 2017 (TCJA), 529s could be used only for college costs. Now they can be used for private K-12 education costs as well.
Front-loading the plan allows earnings to be compounded on more money over a longer time period. In other words, the more you put in initially, the longer that money has to grow and the greater the balance when the funds are needed, especially if you’re not going to need them until college.
The total amount you can contribute to a single 529 plan is set by the state in which the plan is established. The amount varies, but in many states it exceeds $200,000, according to the Securities and Exchange Commission. Your contribution goes in after taxes, so there is no federal tax deduction. Some states, however, offer a deduction for a portion of your contribution.
Contributions grow tax free and can be withdrawn tax free as long as the money is used for qualified educational expenses. There can, however, be gift-tax consequences if you exceed the annual gift-tax limit, which is $15,000 per child or grandchild ($30,000 for spouses who give jointly).
Front-Load Your 529 Plan
You can get around that $15,000 limit via a special – but little known – Internal Revenue Service rule that allows you to front-load a 529 plan for up to five years at one time with no gift-tax consequences. Here’s how it works: Instead of contributing $15,000 per child per year, you contribute $75,000 per child in the first year and treat it as if you gave $15,000 per year for each of five consecutive years.
You can’t make additional contributions (or take money out) until the five years are up, at which time you can contribute another $75,000 for the next five years if you wish. If you and your spouse both contribute (and file jointly), the total amount can be as much as $150,000 for each five-year period.
The Value of Front-Loading
The advantage of front-loading becomes clear when you compare the savings outcome with regular annual contributions. Front-loading $75,000, for example, would compound to $180,496 at 5% over 18 years (compounded annually). If you contributed the same $75,000 over 18 years in annual installments of $4,167, the total would be just $133,117. That’s $47,379 in lost earnings on your contribution.
The numbers are even larger if you and your spouse front-load $150,000 versus annual contributions of $8,333. In that case the total with front-loading would be $360,993, while the total with installments would equal only $266,203, which means $94,790 in lost earnings over 18 years.
Cost of College
A realistic look at the future cost of college for your child or grandchild demonstrates why it is important to squeeze every dollar of earnings out of your 529 plan. By 2036 one year at a public university will cost about $46,000 and the average one-year cost of a private school will be about $75,750, according to a report by Wealthfront. Those costs translate to $184,000 for a four-year degree from a public school and $303,000 for four years at a private institution.
Watch Out for Overfunding
The numbers above may make it seem almost impossible to overfund a 529 plan, but it does happen. It’s an important consideration, because in order for funds to be withdrawn tax free, the money can only be used for qualified educational expenses, as noted under “Contribution Rules.”
In that situation the best choice is to use the excess funds for another family member or even yourself, if you want to go back to school. The fact that the money can now also be used for private K-12 educational expenses will make it easier to find recipients for excess funds if you have them. If another recipient isn’t an option and the excess funds are withdrawn, a 10% penalty and taxes will be due.
However, the taxes and penalty are paid only on the earnings (not the original principal). This means that if the balance in your 529 account after all educational bills are paid is $5,000 and $1,000 of that amount comprises earnings, the penalty would be 10% of $1,000, or $100. Taxes would also be owed on the $1,000.
The Bottom Line
You have to be pretty affluent to afford the large amount needed to front-load a 529 education savings plan. Well-to-do grandparents are most often in that position. The ability to initiate a 529 plan, front-load it and at the same time eliminate that amount from potential estate taxes can be a real benefit. It’s also a very good use for a big bonus or an inheritance, should one come your way. Ultimately, of course, the goal is to help pay for education for your children or grandchildren so they will have the firm footing they need to pursue a meaningful life and career. (For related reading, see "Can a 529 Plan Be Applied to a Student Loan?")