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

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