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How much can you contribute to a 529 plan?

December 12, 2018

A 529 College Savings Plan is a tax-advantaged investment account that allows parents, grandparents, relatives, and friends contribute to an individual’s future college tuition and related costs. Because the account is free of federal tax, and many states also offer a deduction, it is to your advantage to put as much money into the account as possible.

State Limits on Maximum Contributions to 529 College Plans

Each state manages their own 529 College Savings Plan and sets guidelines for maximum contributions. Since the purpose of the 529 plan is to cover college expenses, the state sets a reasonable maximum that would include all possible education expenses including the following:

  • Undergraduate tuition and fees

  • Books

  • Computers and other required equipment

  • Graduate tuition

Room and board may be qualified expenses in some instances. Personal and travel expenses are not eligible expenses. Because the funding includes graduate tuition and related costs, 529 plan maximum contributions range from $300,000-$500,000 for each beneficiary.

For example, California’s maximum contribution amount is $475,000 per beneficiary. Michigan’s maximum contribution for 529 Savings Plans is $500,000. States typically increase their maximum contribution to reflect rises in college tuition.

Factors affecting 529 Contributions

While it may be appealing to contribute the maximum to your 529 Savings Plan, there are other factors to consider including tax consequences for the account holder and other donors.  The following are a few things to consider before making a sizable contribution to a 529 Savings Plan.

Earnings Accrual

Once the account balance reaches the maximum contribution amount, you cannot add additional funds to the account. Accrued earnings also count towards the account’s maximum contribution. Michigan has a $500,000 maximum contribution limit. If you contribute $450,000 to the plan and the account accrues $50,000 in earnings, the account maximum of $500,000 is reached.

The Gift Tax

Donations exceeding the federal gift limit are subject to gift tax. This includes in 529 Savings Plan contributions. In 2018, an individual can give an annual gift of up to $15,000 to a person without paying taxes. If the gift exceeds $15,000, then the donor (not the gift recipient) may be required to pay taxes on the gift amount. For a married couple this amount doubles. For example, a husband and wife can gift $15,000 each (for a total of $30,000) tax-free to the same person.

There’s also a five-year gift option, in which you can donate a lump sum gift spread over five years tax-free. In this case, an individual can contribute $75,000 tax-free to a 529 Savings Plan, or a couple can donate $150,000. For example, if grandparents want to contribute to their grandchild’s 529 College Savings Plan, each grandparent can contribute $75,000 for a total of $150,000 tax-free.

It’s crucial to remember that if you give a lump sum contribution, you cannot gift any additional money to this person over the next five years, for 529 plans or other purposes, without tax consequences. For lump sum five-year gifts, it's necessary to complete IRS Form 709 and elect the five-year gift option.

Lump Sum

Because of the five-year tax option, donating a lump sum may be attractive for several reasons. Contributing a lump sum, allows the account to accrue higher earnings. However, it’s important to be sure that you are happy with the investment portfolio that you choose under the 529 Savings Plan. When contributing high amounts, it may not be possible to change your investment portfolio once the contribution is made.

Exceeding College Expenses

Saving too much for college expenses using the 529 College Savings Plan can hurt you. Here’s an example. A parent in California saves the maximum $475,000 for future college costs. Their child attends an in-state school and uses $100,000 for undergraduate expenses, and $200,000 for graduate expenses, totaling $300,000. The remaining $175,000 may be subject to federal and state tax penalty, in addition to federal income tax on the account earnings if not used for college.

In the above case, changing the beneficiary is another option to withdrawing funds from the 529 plan and owing taxes. Eligible beneficiaries typically include close relatives. The account owner can change the beneficiary to another child in the family, or even a parent can change the beneficiary to himself to use for educational expenses. While saving for a 529 College Plan is a good idea, it’s wise to only save what you are sure that you will use.

Alternatives to Contribution to 529 College Savings Plan

If you have exceeded the gift limit or don’t want to make the maximum contribution, there are other ways that parents and relatives can contribute to their child’s education tax-free. Grandparents can make tuition payments to the college directly. College tuition payments are not considered a taxable gift, but may affect financial aid, so it’s best to do it in the senior year of college, when financial aid may no longer be a consideration.

Multiple 529 Savings Plan

Some parents fund multiple 529 College Savings Plans in the same state or different states for several children at once. Certain state plans may factor 529 Savings Plan contributions in other states, so regardless of where your 529 plan is located, it’s essential to discuss contributions with your plan administrator as you approach plan maximums.

Consult With a Tax Professional

Before making a sizable contribution to a 529 College Savings Plan, whether you are the account holder or a relative or friend, it’s important to discuss the tax consequences with your tax professional. Your tax circumstances will ultimately determine what, if any, tax you may owe as a result of the contribution.