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What happens to a 529 plan if the account owner dies?

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529 college savings plans have different rules about what happens when the account owner or beneficiary dies.

These rules can affect how your account is managed, your taxes and your financial aid is handled.

Whether you’re the account owner or beneficiary of a 529 plan, you should know the rules in case you find yourself in a position where you must act upon the death of someone connected to the plan.

The rules are complicated because each state has its own 529 plan rules.

Account Owners and Beneficiaries

It’s important to remember that a 529 plan has an account owner and an account beneficiary.

In a typical setup, the parent is the account owner and the child is the account beneficiary.

However, the account owner can also be the beneficiary (see Using a 529 Plan for Yourself ).

Beneficiaries may have multiple relationships, such as spouses, siblings, and grandchildren.

What happens if the account owner dies?

The rules regarding the death of the account owner are determined by the 529 plan and state law. Many 529 plans allow the account owner to designate one or more successors when the account is opened. A second successor is sometimes called a contingent owner. A successor can also be designated at a later time.

We recommend having multiple successor owners. Many account owners designate their spouse as the successor owner. But what happens if the account owner and their spouse die at the same time?

Designating successor and alternate owners allows the account owner to choose who will be responsible for the account when they pass away.

No successor owner specified

If no successor is named, the surviving spouse may become the successor. In some cases, the beneficiary may become the account owner (more on this below). In some cases, the executor of the estate may be able to appoint a new account owner (including themselves) or request a refund on behalf of the estate. In other cases, the new account owner must be determined through probate.

You can also designate a beneficiary as a successor account owner. Some 529 plans require the successor owner to be at least 18 years old and a U.S. citizen or permanent resident. If the successor owner is under 18, the account may be transferred to the beneficiary’s surviving parent (if any) or other legal guardian.

A copy of the death certificate is required to transfer an account upon the death of the account owner.

A successor should always be chosen carefully. The account owner can do everything an owner can do, including making investment selections, distributions (including non-qualified distributions), changing beneficiaries, etc. The new account owner can withdraw money for themselves, change beneficiaries to their own children from a previous marriage, etc.

Tax Consequences of Death of 529 Plan Account Owner

When a 529 plan owner dies, the assets in the 529 plan are not considered part of the decedent’s taxable estate, with important exceptions.

Contributions to a 529 plan are considered completed gifts and are immediately excluded from the donor’s estate subject to federal estate tax. [26 USC 529(c)(2)(A)] However, state estate and inheritance taxes may be treated differently.

Five-year gift tax averaging (also known as superfunding) allows a donor to make a lump sum gift and have it treated as if it had accrued pro rata over a five-year period. [26 USC 529(c)(2)(B)] If the donor dies within the five-year period, the portion of the gift that corresponds to the year following the year of the donor’s death is included in the donor’s taxable estate. [26 USC 529(c)(4)(C)]

Impact of the death of a 529 plan beneficiary

In the event of the beneficiary’s death, the account owner can either take the distribution or change the beneficiary to a relative of the previous beneficiary.

Generally, the earnings portion of a non-qualified distribution is treated as taxable income to the recipient, and the earnings portion is also subject to a 10% tax penalty.

However, if the distribution is paid to the beneficiary or the beneficiary’s estate and is made after the beneficiary’s date of death, the 10% 529 plan tax penalty is waived. [26 USC 529(c)(6) with reference to 26 USC 530(d)(4)] The gain portion of a non-qualified distribution is still treated as taxable income to the recipient.

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