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How is a 529 Plan Treated, If It’s Inherited?

Let’s start by defining a 529 plan. A 529 College Savings Plan is a special type of investment account created pursuant to Section 529 of the Internal Revenue Code and state law. At first, 529 plans were a popular way for families to put away funds for college or other post-secondary educational expenses. The 2017 Tax Act has broadened the plans’ scope to include saving for elementary and high school education.

The question raised in a recent article from, “Does a 529 plan become part of someone’s estate? Is inheritance tax due?” presents an interesting situation.

The short answer is no, 529 plan earnings need not be reported on taxes. These plans are exempt from income tax, if they’re used for qualified education expenses. This includes tuition, fees, books, supplies, equipment, along with room and board at eligible institutions.

Any distributions for anything other than qualified education expenses, will result in the earnings being taxed to the recipient with a 10% penalty.

A contribution to a 529 plan is deemed to be a gift by the contributor to the beneficiary, despite the fact that the custodian on the account can withdraw the funds in the account, subject to tax consequences.

The custodian may also transfer all or some of an account to another beneficiary without tax consequences, but that subsequent designated beneficiary must be a member of the prior beneficiary’s extended family, as defined in the Tax Code.

As far as estate taxes are concerned, an interest in a 529 plan typically isn’t included in a decedent’s gross estate for federal estate tax purposes.

However, there are some exceptions to this rule, so you’ll want to speak with an estate planning attorney in your state to be sure you are following the law.

In New Jersey, the general rule is that the plan is subject to state inheritance tax, unless the beneficiary is a Class A beneficiary, which includes grandparents, parents, spouses, descendants or stepchildren. Speak with an estate planning attorney to be sure.

Reference: (October 19, 2018) “Does a 529 plan become part of someone’s estate? Is inheritance tax due?”

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