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529 college savings plans have different rules regarding the death of the account holder or beneficiary.
These rules may affect the control and tax and financial treatment of the account.
Whether you are an account holder or a beneficiary of a 529 plan, you should know the rules in case you ever find yourself in a situation where you need to act upon the death of someone associated with the plan.
The rules are complicated because each state has its own 529 plan regulations.
Account holder vs. beneficiary
It is important to remember that 529 plans have an account owner and an account beneficiary.
In a typical configuration, a parent is the account holder and a child is the account beneficiary.
However, the account owner can also be the beneficiary (see: Using a 529 Plan for Yourself).
Beneficiaries can also be members of several family circles, such as spouses, siblings or grandchildren.
What happens if the account holder dies?
The rules for the death of the account owner are set by the 529 plan and state law. Many 529 plans allow the account owner to name one or more successors when the account is established. A secondary successor is sometimes called a contingent holder. The successors can also be named later.
It makes sense to name several successors. Many account holders name their spouse as their successor. But what happens if the account holder and spouse die at the same time?
By specifying the successor owner and the replacement owner, the account holder can choose who will be responsible for the account after his or her death.
No subsequent owner is specified
If no successor is named, in some cases the surviving spouse becomes the successor. In some cases the beneficiary can become the account holder (more on this below). In some cases the executor can name a new account holder (including themselves) or seek a refund on behalf of the estate. In other cases the new account holder must be determined through probate proceedings.
It is possible to name the beneficiary as the account owner's successor. Some 529 plans require the successor to be at least 18 years old and a U.S. citizen or permanent resident. If the successor is under 18, the account can be transferred to the beneficiary's surviving parent (if any) or other legal guardian.
A copy of the death certificate is required to transfer the account after the death of the account holder.
You should always choose the successor carefully. The account holder can do everything the owner could do, including choosing investments, taking distributions (including non-qualified distributions), and changing the beneficiary. The new account holder could withdraw the money for themselves or change the beneficiary to their own child from a previous marriage.
Tax implications of the death of the 529 plan account holder
When the owner of a 529 plan dies, the assets of the 529 plan are not considered assets of the deceased's taxable estate, with one important exception.
Contributions to a 529 plan are considered a completed gift and are immediately removed from the donor's estate for federal estate tax purposes. [26 USC 529(c)(2)(A)] However, the treatment may be different for state estate and inheritance taxes.
Using the five-year gift tax averaging method (also called superfunding), a donor can make a lump sum gift and treat it as if it were made 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 donation attributable to the years following his death will be included in the donor's taxable estate. [26 USC 529(c)(4)(C)]
Effects of the death of a 529 plan beneficiary
If the beneficiary dies, the account holder can take a distribution or change the beneficiary to a relative of the old beneficiary.
Normally, the income portion of a non-qualified distribution is treated as taxable income of the recipient. The income portion is also subject to a 10% tax penalty.
However, the 10 percent 529 plan tax penalty is waived if the distribution is made to the beneficiary or the beneficiary's estate and occurs on or after the beneficiary's death date. [26 USC 529(c)(6) with reference to 26 USC 530(d)(4)] The income portion of a non-qualified distribution continues to be treated as taxable income for the recipient.
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