Case Study: Grandparents and 529 superfunding

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The concept of Superfunding, or max-funding, or forward gifting or one of several other similarly-coined terms, has to do with maximizing the tax benefits associated with a donor's gifting to a beneficiary using a 529 plan.

Forward gifting refers to taking advantage of a unique provision of Section 529 of the IRS Code allowing people to gift five years' worth of contributions in the present year without incurring a gift tax consequence. The annual gift tax exclusion increased from $14,000 per beneficiary to $15,000 effective Jan 2018.

A nuance of that, used specifically at calendar year-end in most states (and generally by April 15 in seven other states) is a strategy called Superfunding. Think of it this way: If forward gifting could be dubbed "five years gifting today," then Superfunding could be called "SIX years gifting within the month."

Superfunding is executed in two steps, here's an example:

Step 1, Year/Month 1 (December, 2017): A married couple, Jack and Diane, have a $12MM estate as well as a high current income. They want to reduce their estate tax exposure, and heard about the forward gifting concept from their financial advisor. They decide to initiate a forward gifting strategy to its maximum benefit for their granddaughter, Ellen, and contribute $28,000 ($14,000 per person) for the current year, temporarily holding off on executing the forward gift transaction until 2018 in Step 2 below.

Step 2, Year/Month 2 (January, 2018): Jack & Diane complete this strategy by executing the forward gift contribution amount of $150,000. (Remember that the standard gift amount changed effective 2018 to $15,000 per beneficiary from $14,000 so 2 x $15k x 5yrs = $150k) When you look at both months, if they had done the forward gift as the first step, in 2017, they would only be able to contribute $2,000 (topping off the prior $14,000 gifts) because their prior forward-gift contribution from 2017 covers 2018 (and 2019, 2020, and 2021).

By waiting until Year 2 and Month 2 to execute Step 2 to make the forward gift, they are able to gift more, sooner - one extra year sooner - simply because they waited until January 2018. Is this semantics? Kind of. Is this good financial and tax planning, and strategy? Absolutely. This Superfunding strategy helps people who have the available funds to remove more money from their taxable estate SOONER as well as contribute more money into a 529 account sooner, allowing for larger potential state income tax deductions and tax deferred 529 account growth at the same time.

RELATED: 10 rules for superfunding a 529 plan

STRATEGY 1: Forward Gifting, married couple NO Superfunding:
December 2017: Forward gift contribution is made: $28,000 x 5 yrs = $140,000
January 2018: $2,000 gift (Both individuals topping off by $1,000 to the new gift tax exclusion amount, $15,000)
2019: $2,000 gift
2020: $2,000 gift
2021: $2,000 gift

Total removed from estate and gifted, tax-free, between 2017 and 2018: $142,000

STRATEGY 2: Forward Gifting, married couple, WITH Superfunding:

December 2017: Standard gift is made: $14,000 x 2 = $28,000
January 2018: Forward gift contribution is made: $15,000 x 5 years x 2 = $150,000
2019: No gift
2020: No gift 2021: No gift

Total removed from estate and gifted, tax-free, between 2017 and 2018: $178,000

For those skeptics asking themselves "What's the difference?", pointing out that this Superfunding strategy really is about timing, and is somewhat a matter of semantics, my response is "You're mostly right." It really is a matter of perspective - and client circumstances. Continuing with the skeptic's line of thinking, you will notice that in Strategy 1 above, they could simply gift $30k in 2022 and bring the total gift over the same six years to $318k, nearly the same amount as Strategy 2.

Remember, also, that in this example, Jack & Diane have a high current taxable income. If they live in certain states, they would be able to deduct up 100% of their 529 contributions from their current year state taxable income, thus generating a huge state income tax break while they also reduce taxable estate exposure.

Conclusion

Superfunding can be seen in one of two ways: semantics, or an incredible income and estate tax reduction tool. As in most other facets of financial planning, that individual determination can make a significant difference for your clients. When you magnify this example by several beneficiaries, related (i.e. grandchildren) or not, this Superfunding strategy can be instrumental in terms of client tax savings, satisfaction and retention.

Try the Superfunding Calculator to see how this strategy could benefit your clients.