Some people think that multiplying your child’s age by 2,000 will give you the necessary balance of a 529 plan account at that age. This suggests your child would have $34,000 to $36,000 at high school graduation. Sadly, that’s about the cost of one year in college.1 So, while the amount of money you contribute to a 529 account will depend on your specific financial circumstances, a more practical approach might be to save all you can.
What a 529 Plan Account Does
A 529 plan is a tax-advantaged account typically used to save for college. Earnings inside the account don’t get taxed. Then, when you take money out to pay qualified education expenses (things like tuition, fees and other costs required for admission or enrollment), that money isn’t taxed as income.
So, the tax benefits are a big deal. They mean you don’t have to share income or gains with Uncle Sam. Over the course of 22 years (i.e., birth to undergraduate degree), that tax savings can really add up.
529 Plan Contribution Limits
There’s no uniform legal limit to how much you can contribute to a 529 plan account. But there are account balance limits in every state.
Some states offer more than one plan with different limits. But those limits are generally massive. For example, some plans in New Hampshire cap out at $542,000.2 Not the norm, but nearly every 529 plan in America caps lifetime contributions in the hundreds of thousands of dollars. And there’s no rule preventing you from depositing that up front.
Now, there are a couple of issues with this. The first is that most people don’t have a half million bucks lying around to plop into an infant’s college savings fund. The other is that this amount would blow through the federal gift tax exclusion of $15,000 per donor. So, the tax would be huge.
As a practical matter, the maximum a married couple can contribute to a 529 plan account without running into gift tax territory is $30,000 annually. But this is all to make a point. To be safe, you really should save all you can!
Getting Around the Gift tax Exclusion
Now, for those wildly impatient parents looking to get as much money as possible into their kids’ 529 plan accounts as quickly as possible, there is an exception to the annual gift tax limit. You can front-end load 529 plan accounts every five years.
You do this by adding five years’ worth of contributions in one year and then skipping any additional contributions for the next four years. In year six you can repeat the process. And if you really want to be creative there’s a way to juice this up too.
In year one you contribute up to the gift tax limit ($30,000 per child for a married couple) in December. Then in January you deposit an additional $150,000. You skip the next four years’ contributions. In years seven and eight you repeat the process.
Again, this is a lot of money. But it’s to make the same point. Save all you can!
Financial aid and the 529 Plan
Any money you have in a 529 plan account above a very small “allowance” (a few thousand dollars depending on how old you and your spouse are) ends up in the calculation schools use to determine need-based financial aid. Any excess over the allowance could reduce aid awards by up to 5.64%.
Okay, let’s examine this carefully.
If the balance in your 529 plan account exceeds the allowance by a small amount – say $30,000 – the aid reduction would be in the neighborhood of $1,700. A pretty big ding. But over time the tax-free compounding in your 529 plan account makes this hit a little less painful.
But if you’ve saved all you can and the balance in your 529 plan account exceeds the allowance by a big number, then your child probably won’t be eligible for need-based financial aid. Which is the whole point of saving all you can.
Want to see how your plan stacks up? Hit our College Savings Calculator to help develop or fine-tune your education savings plan.
1 The average cost of college in the United States is $35,720 per student, per year. Source: EducationData.org, Average Total Cost of College & Tuition, Updated: May 14, 2021.
2 Source: New Hampshire State Treasury, UNIQUE College Investing Plan.