529 after death of designated beneficiary

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
User avatar
Topic Author
verbose
Posts: 611
Joined: Thu Aug 28, 2008 10:05 am

529 after death of designated beneficiary

Post by verbose »

There is another thread in which I explain that my 14-year-old son died unexpectedly in April 2022.

I’m still working through the paperwork. Death certificates won’t arrive until July at earliest. I know how to deal with his UTMA account. I have to wait for the death certificate and then go through probate.

The 529 is more confusing. The account has almost $60k in it. My son is the designated beneficiary and my husband is account owner. My husband is emotionally incapacitated and almost entirely incapable of dealing with the 529 at this time, so I’m limited in what I can do because I have a female voice and they know I’m not him on the phone.

Questions about the 529:

Is is part of his estate?
Circuit court representative said yes. MOST (Missouri 529 plan) said no. The amount of the 529 would push the estate into full probate from small estate affidavit. We need to know this before we can start probate.

IRS publication 970 says this about the additional tax on distributions:

Quoting:

The 10% additional tax doesn’t apply to the following distributions:

Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary.

End quote

Conclusions:
- The phrase “a beneficiary” is clearly not the designated beneficiary. So, is that any other beneficiary named after the death? So any distribution to a different beneficiary, named after the death, and not used for qualified educational expenses, does not incur 10% additional tax. No timeframe for this exception is given, except “after death.” Does it have to be in the year of death or at any future time after the designated beneficiary died and the beneficiary was then changed to another family member?

- The phrase “to the estate of the designated beneficiary” makes it clear that this could be part of his estate. But it doesn’t explain how/whether this payment happens. I’m assuming that if we withdraw the funds without changing the designated beneficiary, then the funds go to his estate, triggering income taxes for (who?) and forcing the estate into full probate.

We are unable to use the majority of the funds for qualified educational expenses. Our only other child is 20 and in college. Her 529 has almost enough to finish her bachelors degree. We could use maybe $10k additional from the other 529. She will not be attending graduate school (this is pretty certain, given her attitude about school, test anxiety, and her field of study). My husband and I have bachelor’s degrees and no need/want for any additional education.

There is no easy way to split the account. If the beneficiary changes, then it all changes.

So, now what? Do I need a tax accountant? An attorney? Who knows the answers to my questions?
User avatar
arcticpineapplecorp.
Posts: 10244
Joined: Tue Mar 06, 2012 9:22 pm

Re: 529 after death of designated beneficiary

Post by arcticpineapplecorp. »

my condolensces.
Death of account beneficiary

Usually, when a designated beneficiary of a 529 plan dies the account owner retains control and may be able to name a new beneficiary or be allowed to withdraw the account. However, you should look to your plan for guidance when it comes to naming a new beneficiary. Earnings on a distribution because of a beneficiary’s death would be taxable, but the 10 percent early withdrawal penalty would not apply.

Under some circumstances, if a beneficiary dies with a 529 plan balance, some or all of the balance may be included in the beneficiary's estate. If there is a distribution because of the beneficiary’s death, the amount distributed is included in the beneficiary's estate.

On the other hand, if the account owner names a new beneficiary or the account switches to a secondary beneficiary following the first beneficiary's death, the 529 balance would not be included in the beneficiary’s estate since there would not be a distribution.


source: https://www.claconnect.com/resources/ar ... ings-plans
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
User avatar
Topic Author
verbose
Posts: 611
Joined: Thu Aug 28, 2008 10:05 am

Re: 529 after death of designated beneficiary

Post by verbose »

Found this in the 529 plan documents:

If the Beneficiary dies, you may select a new Beneficiary or authorize a payment to a beneficiary of the Beneficiary or the estate of the Beneficiary. A payment to a beneficiary of the Beneficiary or the estate of the Beneficiary will not be subject to the additional 10% federal penalty tax on earnings, but earnings will be subject to any applicable federal and state income taxes at the recipient’s (the party receiving the withdrawal) tax rate. If you select a new Beneficiary who is a “member of the family,” you will not owe federal income tax or a penalty on withdrawals.

Biggest question: who is “a beneficiary of the Beneficiary”? (Capitalized just like in the quote above)

Another question: What is meant by “you will not owe federal income tax or a penalty on withdrawals”? Does this mean if the beneficiary is changed, future withdrawals are not subject to federal taxes? Or does it just mean the act of changing the beneficiary is not taxable? But it’s already not a taxable event, so why state it here? If I just change the beneficiary, no withdrawals are made, so no taxes are owed. Does this sentence apply to future withdrawals after changing the beneficiary? That seems unlikely. I can’t even tell why the last sentence is included in this paragraph, much less what it’s trying to say.
SouthernInvestor
Posts: 75
Joined: Thu Jul 15, 2021 6:13 am

Re: 529 after death of designated beneficiary

Post by SouthernInvestor »

I know not what you were looking for, but I will pray for your son and your family.
User avatar
MP123
Posts: 2676
Joined: Thu Feb 16, 2017 3:32 pm

Re: 529 after death of designated beneficiary

Post by MP123 »

verbose wrote: Fri May 13, 2022 1:36 pm Another question: What is meant by “you will not owe federal income tax or a penalty on withdrawals”? Does this mean if the beneficiary is changed, future withdrawals are not subject to federal taxes? Or does it just mean the act of changing the beneficiary is not taxable? But it’s already not a taxable event, so why state it here? If I just change the beneficiary, no withdrawals are made, so no taxes are owed. Does this sentence apply to future withdrawals after changing the beneficiary? That seems unlikely. I can’t even tell why the last sentence is included in this paragraph, much less what it’s trying to say.
I'm very sorry to hear of your loss.

You can change the 529 plan beneficiary to another member of your son's family (you, for example), but changing it to anyone outside the family would be a non-qualified distribution and would be taxable.
986racer
Posts: 259
Joined: Thu Aug 11, 2016 10:09 am

Re: 529 after death of designated beneficiary

Post by 986racer »

I wouldn’t put much weight into what the 529 plan says about owing federal taxes as the plan doesn’t have the ability to override federal tax laws. My guess is that it is trying to say that the transfer to a family member would be tax free and penalty free and that is in line with IRS 970.

I think the key question is what you pointed out in the OP. It appears the IRS 970 says you can appoint a new beneficiary and that beneficiary can pull out the money without paying a penalty (taxes would still be owed on gains), however there must be some type of time limit when that distribution should be made. Hopefully a tax expert can provide guidance on that.

My guess would be that if you want to withdraw the money without the penalty, you should do it almost immediately after naming the new beneficiary.
WarAdmiral
Posts: 354
Joined: Mon Jan 20, 2020 7:09 pm
Location: Boston

Re: 529 after death of designated beneficiary

Post by WarAdmiral »

First my condolences.

I'm no expert but it seems like if you wanted to withdraw the funds, you could do so without the 10% penalty but will still pay the federal tax.

However, you can take it slow by adding your other child or even yourself as a beneficiary and then let the money grow in the plan. Also, at a later date, name a new grandchild as a new beneficiary.

I don't believe you have a timeline to hurry or act here. Sorry again for your loss.
SchruteB&B
Posts: 538
Joined: Mon Jul 02, 2018 7:48 am

Re: 529 after death of designated beneficiary

Post by SchruteB&B »

I am very sorry for your loss.

I would probably change the beneficiary of the 529 to your daughter at this point. That seems like it would eliminate any questions about whether it is in the estate or not and free you from having to make any further decisions about it right now. Use some of the funds as needed for your daughter’s college. If, after college she does not pursue grad school, you could either leave the money in the 529 for any potential children she might have someday. Or, when she is first working she will perhaps be in a low tax bracket. At that time, you might want to distribute to her for a car, a house etc. (and yes, a penalty and ordinary income tax would need to be paid at this time)

This may not produce the most optimal tax situation but it is easy and straightforward to do right now.

You can download a form from the Missouri 529 site to change the beneficiary of the 529. No phone call needed.
User avatar
Beachey
Posts: 239
Joined: Wed Sep 02, 2020 9:54 am

Re: 529 after death of designated beneficiary

Post by Beachey »

My condolences. I believe you mentioned there are nieces/nephews. You should be able to make them the beneficiary as a non-taxable event if that is your choice.
Rules for Changing the Beneficiary on a 529 Plan
The Internal Revenue Service (IRS) has specific guidelines for changing the beneficiary of a 529 savings plan, but it's not an overly complicated process. The most important thing is that the new designated beneficiary must be a qualified individual, which means a member of the beneficiary's family. That includes:

Spouse
In-laws, including a mother-in-law, father-in-law, brother-in-law, or sister-in-law
Children, including step-children, foster children, or adopted children
Siblings, including step-siblings
Nieces and nephews
Aunts and uncles
First cousins
https://www.thebalance.com/transferring ... ry-4157853
Morgan22
Posts: 91
Joined: Thu Oct 29, 2015 12:30 pm

Re: 529 after death of designated beneficiary

Post by Morgan22 »

verbose wrote: Fri May 13, 2022 1:36 pm Found this in the 529 plan documents:

If the Beneficiary dies, you may select a new Beneficiary or authorize a payment to a beneficiary of the Beneficiary or the estate of the Beneficiary. A payment to a beneficiary of the Beneficiary or the estate of the Beneficiary will not be subject to the additional 10% federal penalty tax on earnings, but earnings will be subject to any applicable federal and state income taxes at the recipient’s (the party receiving the withdrawal) tax rate. If you select a new Beneficiary who is a “member of the family,” you will not owe federal income tax or a penalty on withdrawals.

Biggest question: who is “a beneficiary of the Beneficiary”? (Capitalized just like in the quote above)

Another question: What is meant by “you will not owe federal income tax or a penalty on withdrawals”? Does this mean if the beneficiary is changed, future withdrawals are not subject to federal taxes? Or does it just mean the act of changing the beneficiary is not taxable? But it’s already not a taxable event, so why state it here? If I just change the beneficiary, no withdrawals are made, so no taxes are owed. Does this sentence apply to future withdrawals after changing the beneficiary? That seems unlikely. I can’t even tell why the last sentence is included in this paragraph, much less what it’s trying to say.
I'm sorry for your loss.

Does your husband want to withdraw all funds? Is that why you are asking these questions? If not, just change the beneficiary to your daughter for now. There will be no taxes due if you just change the beneficiary to a family member. In a year or so, revisit the decision if needed.

I have changed the beneficiary on one of the 529 plans that I owned. But not under the same circumstances. It was a very simple process and was done online, but I owned Utah plans at the time. Not sure if you can just as easily do with your state plan, or if you have to do via paper.
User avatar
Topic Author
verbose
Posts: 611
Joined: Thu Aug 28, 2008 10:05 am

Re: 529 after death of designated beneficiary

Post by verbose »

After reading more and trying to understand how this works, I think I get it.

We can withdraw the funds now. I believe that "a beneficiary of the Beneficiary" is any heir, which in this case (intestate law in Missouri) is myself, my husband or our daughter. We would owe taxes on the earnings (24% federal) and state taxes (5.4%) on all of it (earnings plus recapture on principal). And if we do that, it's part of his estate and I have to pay an attorney for full probate.

Or, we can change the beneficiary. The beneficiary change, if to a member of family, is a tax-free event. The funds leave my son's estate and we go from there. At that point, normal withdrawal and taxation rules apply.

I've asked the parents of his cousins if they can help to get the funds out of the 529 tax-free. All the cousins are younger and they will be able to use the funds in their own 529 accounts. It's going to take a while, but I think that is the best way to get the funds out. Their parents will transfer cash to us in return for funds rolled over to the 529 accounts. Our state does not have recapture taxes on rollovers to out-of-state 529 accounts.

So, with this information, I think I will go ahead and change the beneficiary to my daughter. I may wait until she's graduated (in about two years) to being rolling over the remainder to the cousins, none of whom starts college soon.

Thanks for the replies--that helped me think through this and make sense of what I'd read.
Post Reply