Most families recognize the tax benefits of a 529 college savings plan. Contributions grow and are withdrawn tax-free as long as the money is used for qualified education expenses.
There is another advantage that may be even more powerful over time: A 529 plan is an owner-controlled account.
With a 529 account, the owner can make investment changes twice per year, direct withdrawals, and change beneficiaries at any time. Sometimes a child does not finish college, takes on a full-time job, or simply does not need all the assets in the college fund. The beneficiary flexibility allows parents to make changes over time.
Penalty-free beneficiary change
1. Change to a “member of the family”
A 529 account owner can change the beneficiary at any time without tax consequences if the new beneficiary is a member of the family. A member of the family is defined in Internal Revenue Code section 529.
If the new beneficiary is not a member of the family, the change will be treated as a non-qualified distribution. The earnings portion of the account may be subject to income tax and a 10% penalty. In addition, the IRS may treat the change of beneficiary as a gift for the new beneficiary.
2. New beneficiary is in the same generation or older
If the new beneficiary is a member of the family, in the same generation or older, there is no penalty. If the new beneficiary is part of a later, or younger, generation, the change may be treated as a gift for tax purposes.
It is important to note that there are annual, lifetime, and five-year election exclusions for the purposes of gift taxes.
Annual. Individuals can gift up to $15,000 per year per beneficiary ($30,000 for married couples, as of 2019)
Lifetime. The lifetime gift tax limit is $11.4 million (as of 2019)
Five-year front-loading. With a 529 plan, parents and grandparents can gift up to five years’ worth of gifts ($75,000 single and $150,000 for couples) in a single year without incurring any gift taxes (as of 2019). In order to qualify for the five-year election, the contribution must be submitted via a federal gift tax return (Form 709) https://www.fa-mag.com/news/avoiding-section-529-plan-pitfalls-6204.html
In addition, taxpayers must report 20% of the total 529 plan contribution each year for five years. If a grandparent passes away during the five-year duration, a pro rata portion of the contribution will be added back to their estate.
Examples to consider:
- The parent owns one 529 plan for Child A. Child A does not go to school or has money left over after attending a four-year college. There are no tax implications if the parent decides to change the beneficiary to a sibling (Child B).
- If a grandparent owns the account for the benefit of a grandchild, they can change the beneficiary to another grandchild, a grandniece or nephew, or the child’s parents, without tax consequences. They must, however, follow the gift tax rules detailed in the generation-skipping transfer tax.
Using a 529 in perpetuity. If the beneficiary has money left over, the account can continue and pass the money to the next generation. But the transfer would be considered a new gift to a younger generation and subject to gift tax limits.
Establish one account for the family. With a 529 plan, there can only be one owner and one beneficiary at a time. If there are two family members that are four or more years apart in age, it may be easier to have only one account to manage. Remember to review the investment options in order to meet the new student’s time horizon and goals. Account owners can only make investment changes twice per year. However, if the investments are changed while changing the beneficiary, it will not count against the annual limit.
When a beneficiary change may make sense
1. When there is only one account and the first beneficiary no longer needs the assets.
2. To reduce the tax liability on unused funds, change the investment options, or roll over assets to another 529 plan.
3. When individuals without children want to plan ahead. Account owners can name themselves the beneficiary and then change it after the child is born.
When a beneficiary change may not make sense
1. If a child decides not to go to a four-year college. The funds can still be used for other qualified educational expenses such as trade schools, associate programs, or enrollment in online classes.
2. When your child completes an undergraduate program. There is no need to change the beneficiary immediately. There may be additional fees and expenses owed. The student may decide to take a break and then go to graduate school.
3. To transfer money from one child to another, parents may consider a rollover rather than a beneficiary change. A rollover is tax-free as long as the funds are reinvested in another 529 plan within 60 days.
4. When a generation-skipping tax will occur.
For more information about 529 plans, including resources and tools to help families plan and save for education, meet with a financial advisor or visit Putnam.com/529. The IRS has resources to help families and students understand tax benefits when paying for college including IRS Publication 970 Tax Benefits for Education, as well as facts about 529 plans.
For informational purposes only. Not an investment recommendation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions. Putnam does not provide tax or legal advice.