Everybody knows college is expensive. That’s why it pays to start investing for the future education of the kids you love now.
Investing now enables you to slowly build up a lump sum over time that can cover a huge chunk (if not all) of the higher education fees you and the kids in your life could end up getting saddled with in a decade or two from a student loan.
One of the most popular ways to save for a child’s future college tuition is to set up a 529 savings plan.
A 529 college savings plan is a tax-efficient savings vehicle that allows you to accumulate a big enough nest egg to cover the future cost of a child’s higher education tax-free.
That being said, it’s important to note that all 529 plans work a little bit differently — and there are legal limits to the amount of money you’re allowed to invest in a 529 plan.
This guide explains what 529 contribution limits are, the 529 contribution limits for 2021, how the gift tax impacts your contributions, and how you can supplement your investment using a UGMA custodial account.
What are 529 Contribution Limits?
A 529 plan is one of a handful of popular options for saving for a child’s college education.
Like a Roth IRA, a 529 account lets you build a nest egg for loved ones in your life. And both accounts let you make a qualified withdrawal tax-free.
Unlike an IRA, the Internal Revenue Service (IRS) doesn’t have an annual contribution limit that it imposes on 529 plans. Instead, limits are based on aggregate contributions and controlled by each U.S. state.
What’s an aggregate contribution? It’s basically just a fancy way of describing the sum of every cash contribution you’ve ever made to your account over its lifespan.
Because most 529 plans don’t have an annual contribution limit, you can add a particularly large amount of funds to a child’s 529 account any given tax year without getting punished by the IRS — as long as you aren’t going over the aggregate 529 plan limit in your state.
Although it’s not super common, it’s important to note a few states, such as Missouri, do impose an annual limit on 529 contributions for certain plans. These amounts can change on an annual basis.
There can also be obstacles to making large contributions in a single year (like the federal gift tax) — but we’ll break those down shortly.
529 contribution limits 2023
We’ve already mentioned that 529 contribution limits vary by plan and state. Well, when you pool them all together and zoom out for a bit of context, there are about 100 different 529 plans that various institutions across the U.S. currently offer.
There’s no federal tax 529 contribution limit in 2023 that you have to follow.
But that doesn’t mean your 529 plan won't have a cap. It just means you need to do your homework and research each investment option available to you.
With most 529 plans, there are two different contribution limit types: an aggregate (or lifetime) limit and an annual limit.
You also have your state tax deduction limit, which we will explain in more detail in a bit.
Most state-sponsored 529s don’t have an annual limit — but there are a few exceptions to that rule.
For example, if you live in Missouri and want to take out a MO ABLE Stable plan for a child, the standard 2023 contribution limit is $17,000. If you’re employed, you may be able to contribute an additional $13,590 from your income. This would increase your total yearly contribution limit to $30,590. If you're receiving Supplemental Security Income (SSI), an account balance above $100,000 could impact your ability to receive SSI benefits.
Other plans don’t bother with an annual contribution limit. Instead, they only impose an aggregate limit — and generally speaking, most limits today are around $500,000.
For example, let’s say the child you’re investing for lives in Arizona, and so you decide to set up an AZ529 Plan.
With the AZ529 Plan, there’s currently a maximum account balance limit of $531,000. You can contribute as much money as you want in a single year without getting penalized. But remember those tax deduction limits we mentioned earlier? Well, they do apply here.
Although you can contribute as much as you’d like to an AZ529 Plan in any given year, only $2,000 worth of your annual contributions are eligible for a state tax deduction. If you and your spouse file as a married couple, that limit increases to $4,000 per year.
The same rules apply to the Direct Plan that New York residents could choose to set up as part of New York's 529 College Savings Program.
The Direct Plan aggregate contribution limit for 2023 is $520,000 per child. But you can only claim $5,000 worth of contributions as a state deduction on your annual tax return. You can claim up to $10,000 if filing with your spouse.
So you get the idea: each 529 plan has different contribution limits for 2023.
Some plans have an annual contribution limit, while others don’t. Even if the plan you select for a child doesn’t include an annual contribution limit, there is always going to be a cap on your lifetime contributions.
Likewise, every plan is going to have a limit on how much of your contributions will be tax-deductible.
How Does The Gift Tax Affect 529 Contributions?
When you’re saving cash for a major tuition expense for a child in your life using a 529 plan, every single contribution you make is going to be considered a “gift” for tax purposes.
This means there are critical tax implications you need to bear in mind.
The Internal Revenue Service (IRS) imposes a cap on the amount of money you’re allowed to give to a child before taxes are going to need to be applied to that gift. This is known as the “gift tax,” and the tax-free cap is referred to as the gift tax limit (or “gift tax exclusion”).
There are two kinds of federal gift tax exclusions that you should know about: the annual gift tax limit and the lifetime gift tax exclusion.
In 2023, the annual gift tax limit is $17,000 per recipient. That means you could deposit up to $17,000 per year for multiple children without having to worry about paying the gift tax.
Just like the other tax stuff we’ve already covered, it’s important to note that this limit doubles if you and your spouse jointly file taxes. Joint-filers can gift $34,000 per child per year without having to pay the tax.
But you also have a lifetime exclusion. In 2023, the lifetime gift tax limit is $12.92 million.
That means you can gift a child millions of dollars over the course of your lifetime without having to pay the gift tax.
If your total gifts to an individual are going to be more than $17,000 this year, the excess amount will be counted against your lifetime estate and gift tax exemption.
That means if you fail to reach your lifetime gift tax limit, you might not ultimately be taxed on the gift — but you’ll still have to report it to the IRS.
You also need to be aware that the annual gift tax exclusion amount also includes non-529 gifts. You need to be sure to include any cash or property gifts in your overall totals when you’re doing your taxes.
So, how do you report gifted contributions to a 529 account?
If you’ve gifted within your annual gift tax limit, you don’t have to report it to the IRS. That being said, it probably is worth claiming as a deductible as part of your state income tax return.
But if you do gift above your exclusion limit any given year, you’ll need to report that contribution when you file your taxes using IRS Form 709.
Just to be clear: the gifter is the individual that’s supposed to report a gift to the IRS. It’s not the giftee’s responsibility unless the two parties reach an agreement stating otherwise.
It’s also important to bear in mind that there’s no joint gift-tax return. That means you and your spouse will each have to file IRS Form 709 separately, even if you file your taxes together.
What is the five-year gift tax averaging?
Although you need to think hard about the IRS gift tax when you invest money into a 529 plan, there’s a way you can contribute more than your annual exclusion without having to pay the gift tax.
In fact, as of 2023, an individual can contribute up to $85,000 to a 529 plan if they treat the contribution as if it were spread over a five-year period. This method of gifting is what’s known as the “five-year election” or “five-year gift tax averaging.”
For example, let’s say you want to contribute $80,000 ($170,000 if married filing jointly) to a child’s 529 plan in 2023. The following year, you might decide you want to contribute another $5,000 to that child’s 529 account for 2024.
Even though you’ve gone way over the $17,000 gift tax limit one year, it’s okay — as long as you don’t contribute any more cash or assets to the account until 2028 (unless the limit is increased.)
This is a great way to work around the gift tax exclusion for a large one-off gift contribution to a 529 account. But you need to make sure you’re organized and stay within the rules to avoid running into trouble later.
If you decide to use five-year gift tax averaging, you still need to report your gifts to the IRS. Just like a normal gift above the annual limit, this can be done by using IRS Form 709 for each of the five years you’re using for your accounting period.
How to Use a Custodial Account to Boost Your Investments
Whether or not you choose a 529 plan with an annual contribution limit (or low lifetime limit), you may want to pursue a supplementary investment vehicle alongside a 529 to make sure you’ve got all your bases covered.
This is where a UGMA custodial account comes to the rescue.
A UGMA custodial account is an investment vehicle that lets an adult save for a child’s future by setting up an account on their behalf.
Until the child reaches the “age of majority” in their state (usually either 18 or 21), the adult manages all the assets in the custodial account as its “custodian.”
But everything in the account is still the legal property of the child, which can be a real tax-saver for the adults doing all the saving. This is because the IRS taxes income generated from custodial accounts at the child’s lower tax rate, up to a certain level.
Two of the biggest advantages custodial accounts have is that they don’t have contribution limits, and the withdrawal rules aren’t as rigid as 529 plans.
While 529 plans have strict parameters around what counts as a qualified education expense, a designated beneficiary can use the funds in their custodial account for whatever they want when they hit the age of majority.
Translation: a 529 plan is a flexible and tax-efficient way to save for a child’s future education.
But a 529 plan won’t cover every type of educational expense — and there’s always the chance that the kids in your life choose to skip higher education. By investing in a custodial account alongside your 529, you’ll be better prepared to help fund a child’s future.
If you’re looking for a way to save for a child’s future college expenses with a tax benefit, a 529 plan is a pretty smart way to do it.
But it’s important to remember that some state 529 plans limit 529 contributions annually, some limit aggregate contributions, and you should expect a limit on what’s tax-deductible.
You also need to remember that 529 contributions fall under the rules of gift tax — and so you need to stay organized and do your homework to make sure you’re sticking to the rules in your state.
If you want to supplement your 529 investment, a custodial account is a fantastic place to start.
Download the EarlyBird app now and start gifting towards the financial futures of the kids in your life.
This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.