529 college savings plans have different rules for what happens when the account owner or the beneficiary dies.
These rules can affect the control and tax and financial aid treatment of the account.
Whether you are the account owner or beneficiary of a 529 plan, you'll want to be aware of the rules in case you're ever in a position where you must act on the death of a person related to the plan.
The rules are complicated because each state has it's own 529 plan rules.
Account Owner vs. Beneficiary
It's important to remember that 529 plans have an account owner and an account beneficiary.
In a typical setup, a parent is the account owner, and a child is the account beneficiary.
However, the account owner can also be the beneficiary (see: using a 529 plan for yourself).
The beneficiary can also be a number of relationships, including a spouse, sibling, or grandchild.
What Happens When The Account Owner Dies
The rules for death of the account owner are specified by the 529 plan and state law. Many 529 plans allow the account owner to specify one or more successor owners when setting up the account. A secondary successor owner is sometimes called a contingent owner. The successor owners can also be specified later.
It's a good idea to set up multiple successor owners. Many account owners specify their spouse as the successor owner. But what happens if the account owner and their spouse pass away at the same time?
Specifying the successor owner and contingent owner lets the account owner choose who becomes responsible for the account upon their death.
No Successor Owner Is Specified
If no successor owner is specified, in some cases the surviving spouse will become the successor owner. In some cases the beneficiary may become the account owner (more on that below). In some cases the executor of the estate can name a new account owner (including themselves) or request a refund on behalf of the estate. In other cases the new account owner will have to be decided through probate.
It is possible to name the beneficiary as the 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 age 18, the account may be transferred to the beneficiary’s surviving parent, if any, or other legal guardian.
To transfer the account upon death of the account owner, a copy of the death certificate will be required.
You should always choose the successor owner carefully. The account owner can do anything the owner could do, including choosing investments, making distributions (including non-qualified distributions) and changing the beneficiary. The new account owner could take out the money to use for themselves or change the beneficiary to their own child from a prior marriage.
Tax Impact of the Death of the 529 Plan Account Owner
When the owner of a 529 plan dies, the assets of the 529 plan are not considered assets of the decedent’s taxable estate, with an important exception.
Contributions to a 529 plan are considered to be a completed gift and are immediately removed from the donor’s estate for federal estate tax purposes. [26 USC 529(c)(2)(A)] The treatment may, however, be different for state estate and inheritance taxes.
Five-year gift-tax averaging, also known as superfunding, lets a donor make a lump-sum contribution and have it treated as occurring proportionately over a five-year period. [26 USC 529(c)(2)(B)] If the donor dies within the five-year period, the portion of the contribution corresponding to the years after the year of death will be included in the donor’s taxable estate. [26 USC 529(c)(4)(C)]
Impact of the Death of the Beneficiary of a 529 Plan
If the beneficiary dies, the account owner can take a distribution or change the beneficiary to a relative of the old beneficiary.
Normally, the earnings portion of a non-qualified distribution will be treated as taxable income to the recipient. The earnings portion will also be subject to a 10% tax penalty.
However, the 10% 529 plan tax penalty is waived if the distribution is paid to the beneficiary or the beneficiary’s estate and occurs on or after the date of death of the beneficiary. [26 USC 529(c)(6) with reference to 26 USC 530(d)(4)] The earnings portion of a non-qualified distribution is still treated as taxable income to the recipient.
Editor: Colin Graves Reviewed by: Robert Farrington
Mark Kantrowitz is an expert on student financial aid, scholarships, 529 plans, and student loans. He has been quoted in more than 10,000 newspaper and magazine articles about college admissions and financial aid. Mark has written for the New York Times, Wall Street Journal, Washington Post, Reuters, USA Today, MarketWatch, Money Magazine, Forbes, Newsweek, and Time. You can find his work on Student Aid Policy here.
Mark is the author of five bestselling books about scholarships and financial aid and holds seven patents. Mark serves on the editorial board of the Journal of Student Financial Aid, the editorial advisory board of Bottom Line/Personal, and is a member of the board of trustees of the Center for Excellence in Education. He previously served as a member of the board of directors of the National Scholarship Providers Association. Mark has two Bachelor’s degrees in mathematics and philosophy from the Massachusetts Institute of Technology (MIT) and a Master’s degree in computer science from Carnegie Mellon University (CMU).