According to 2016 data from T. Rowe Price, on average, parents spent $422 on holiday gift per child, with 34% spending $500 or more. But, what if instead of buying material gifts, parents and grandparents made a contribution to the child’s 529 college savings plan?
A gift of college savings is more meaningful and lasting than a traditional present. The money you invest grows tax-deferred and can be withdrawn tax-free to pay for qualified education expenses like:
- College tuition
- Room and board if the student is enrolled on at least a half-time basis
- Supplies and equipment required for class
- Computers, Software and Internet access
- Up to $10,000 per year in K-12 tuition
Depending on where you live, you may also qualify for a state income tax benefit when you contribute to a 529 plan. Many states allow residents to deduct all or a portion of their annual 529 plan contributions from state income taxes, regardless of whether or not they are the 529 plan account owner.
How much will college cost?
According to the latest Trends in College Pricing report from the College Board, the average published costs of tuition, fees and room and board for the 2019-20 academic year were:
- Public 4-year in-state college – $21,950
- Public 4-year out-of-state college – $38,330
- 4-year private non-profit college – $49,870
Using the current inflation rates of 2.6%, 2.5% and 3.3%, the total 4-year cost of college in 18 years will be around $145,000, $248,000 and $376,000.
What can a $500 college savings gift pay for?
Your holiday gift may not cover all (or even most) of a child’s future college costs, but even a modest 529 plan contribution will grow over time and reduce the amount the child has to borrow in student loans.
A baby’s first holiday is the best time to give a gift of college savings, since the gift has 18 years to compound tax-free in a 529 plan. For example, if you were able to give a $500 college savings gift each holiday season until college, your gift could potentially grow to $16,380 (assuming a 6% annual interest rate), which could cover costs of:
- One year of tuition and fees at a public 4-year in-state college
- One year of room and board at a private 4-year college
A one-time gift of $500 can potentially grow to $1,427 over 18 years, and may be able to cover costs of:
- One year’s worth of books and supplies
- A laptop
- One year’s worth of internet service
Older children can also benefit from a gift of college savings, even if they’re already in high school. A freshman in high school could save their 529 plan funds to pay for their fourth year of college. An annual holiday gift of $500 can potentially grow to $3,831 over six years, assuming the gifts are invested in a conservative 529 plan portfolio with a 3% annual interest rate.
What about 529 plan gifts that are less than $500?
You don’t have to give a child a $500 for the gift to be meaningful. Every dollar you save for college today is one dollar less that they will have to borrow in student loans. For example, assuming your gift is invested in a 529 plan portfolio with a 6% annual interest rate and an 18-year time horizon:
- A gift of $100 today could grow to $285
- A recurring annual $100 gift could grow to $3,376
- A gift of $50 today could grow to $143
- A recurring annual $50 gift could grow to $1,688
- A gift of $25 today could grow to $71
- A recurring annual gift of $25 could grow to $844
What’s the maximum amount that can be gifted to a 529 plan?
529 plans do not have annual contribution limits, but each state has an aggregate limit that is based on the total cost of the most expensive four-year college in that state. Many states have aggregate limits above $400,000.
Some grandparents take advantage of the high contribution limits to use a 529 plan as an estate planning strategy. Up to $15,000 per donor per beneficiary qualifies for the annual gift tax exclusion and does not count against a taxpayer’s lifetime gift tax exemption of $11.58 million. There is also an option to use 5-year gift tax averaging to contribute up to $75,000 if the contribution is treated as if it were made over a five-year period.
How to contribute to a child’s 529 plan
Grandparents, friends and other relatives can contribute to a 529 plan that is owned by the child’s parent or they can open an account in their own name. Many 529 plans have gifting platforms that accept and track online gift contributions. Or, you can make a contribution by check, purchase a Gift of College gift card, or give a 529 plan gift through CollegeBacker. Check with the child’s parent about the best way to contribute.
If you prefer to retain control of the assets until it’s time to pay for college, you may want to open an account in your own name. Many 529 plans have very small minimum contribution requirements (or none at all). This also allows to the option to change the beneficiary to another child in the event that the original beneficiary doesn’t go to college.
It may be better for a grandparent to open a custodial 529 plan account for the grandchild with the grandparent as custodian than for the grandparent to open a grandparent-owned 529 plan. When a 529 plan is owned by someone other than the student or the student’s parent, it can hurt the student’s eligibility for need-based financial aid.