What Happens to a 529 Plan if the Beneficiary Dies?
Learn about managing a 529 college savings plan and its financial implications when the named beneficiary passes away.
A 529 plan is a tax-advantaged investment account designed to help families save for various education expenses. These plans allow money to grow without federal income tax, and withdrawals are also tax-free when used for qualified education costs. While establishing a 529 plan involves planning for a beneficiary’s future, unforeseen circumstances can arise.
Transferring the 529 to a New Beneficiary
When a 529 plan beneficiary dies, the account owner generally retains control over the funds. One primary option is to change the beneficiary to another eligible individual. This transfer can be completed without triggering any tax implications, provided the new beneficiary is a qualified family member of the original beneficiary.
An eligible family member includes:
A sibling, step-sibling, parent, grandparent, aunt, uncle, first cousin, niece, or nephew of the original beneficiary.
The spouse of any of these individuals.
The new beneficiary’s own child or descendant.
To initiate this process, the account owner typically needs to contact their 529 plan administrator. They will then complete a “change of beneficiary” form and submit it along with any required documentation, such as the death certificate of the original beneficiary.
Withdrawing the Funds
Another option available to a 529 plan account owner, if the beneficiary passes away, is to withdraw the funds. This involves contacting the 529 plan administrator to initiate the withdrawal process.
While distributions from a 529 plan are generally intended for qualified education expenses, a withdrawal made after the beneficiary’s death is considered a non-qualified distribution. Typically, non-qualified withdrawals are subject to income tax on the earnings portion and an additional federal penalty. However, a specific exception applies in the unfortunate event of a beneficiary’s death. The usual 10% additional federal tax (penalty) on non-qualified withdrawals is waived in this circumstance. The account owner should understand that while the penalty is waived, the earnings portion of the withdrawal remains subject to federal income tax.
Tax Treatment of Withdrawals
When funds are withdrawn from a 529 plan following the beneficiary’s death, the tax treatment of the distribution is distinct. The earnings accumulated within the 529 plan are subject to federal income tax. This means that any growth on the original contributions will be taxed at the recipient’s ordinary income tax rate.
A significant aspect of this tax treatment is the waiver of the 10% additional federal tax on non-qualified distributions. This penalty, normally applied to withdrawals not used for qualified education expenses, is specifically waived when the distribution occurs after the beneficiary’s death. The plan administrator typically issues Form 1099-Q, “Payments from Qualified Education Programs (Under Sections 529 and 530),” to report the distribution. This form will indicate the gross distribution, the earnings portion, and the principal portion, which the recipient will then use for federal income tax reporting.