529 account mistakes: why selecting a successor owner is an important consideration
529 Accounts and Asset Ownership
Many parents and grandparents establish 529 plan Education Savings Accounts for their children or grandchildren to help pay for future education expenses. 529 accounts are state sponsored investment plan accounts that offer tax free growth when the funds are used to pay for private K-12 or college expenses. Some state plans even give taxpayers an annual state deduction for making contributions. These tax benefits make 529 plans an attractive option for helping to meet education savings goals.
529 Plan Owner vs. Beneficiary
When created, a 529 plan account has a single owner and a single beneficiary. Typically the owner is the adult who opens the account, and the beneficiary is a child who the owner plans to use the account for at some point in the future. Anyone can contribute to a 529 plan (subject to annual limits) so often one parent will be the account owner and accept all family or gift contributions on the child’s behalf in their account, effectively taking control of the funds on behalf of the child.
An important distinction to remember is that the parent is always the owner of the funds, and the child is the current beneficiary of the funds while the account exists. The child has no ownership claim to the money even if the funds were put in the account to benefit them by a 3rd party (grandparent or other relative). If a student ends up not attending college or has funds left over, the account owner can change the account beneficiary to another child or relative (or almost anyone really) so that they can benefit from the account.
The account owner can also has the option to take the funds out of the account at any time and use them for a different purpose. There are no specific restrictions as to how the funds can be used other than taxes and a 10% penalty are due on the growth of any withdraws not used for qualified education purposes. Sometimes parents will choose to hold any remaining assets in the account for the anticipation of grandchildren or another beneficiary down the road. An immediate decision is not needed.
What happens if a 529 Account Owner Dies?
Periodically, 529 account owners should conduct a review of their account beneficiary and successor owners (if they have them already established) to ensure the continuity of their family’s education goals.
If something were to happen to an account owner, the account beneficiary (typically the child) becomes the inheritor if they are over 18 and would become the account owner. As the owner (and the beneficiary), they would be able to use that account for their education purposes. However, as discussed above, the owner could also use the funds for whatever else they’d like and be subject to taxes and penalties. For this reason, leaving a large 529 plan account to an 18-year-old might not be the best plan.
Avoiding 529 account mistakes
If the beneficiary is under 18, the new owner selection can vary according to state rules. If a will or trust exists, that document may name a successor owner. If it doesn’t, it could be up to probate or an executor to assume the role of owner or appoint an owner on the child’s behalf.
There is an easy way to avoid this situation: An owner can add a successor owner to the account instead.
What we see often is that the owner will name their spouse, the child’s other parent or even a third-party person so that a trusted adult would remain in control of the account should a death occur. It also may be prudent to list a Secondary Account Successor in the event something happened to both the owner and successor owner simultaneously or if the successor owner predeceases the owner before the account records can be updated. This might be a grandparent, relative or family friend.
To be clear, a successor owner becomes the new owner of the account should something happen to the original owner, not just the trustee for the current beneficiary. For example, if a secondary successor took ownership of the account, that person would be the owner of the account and could change the beneficiary to someone other than the intended beneficiary if they chose to do so. They could also withdraw the funds and use them for something else as they saw fit. They would be in full control of the assets. For this reason, it is important to weigh the pros and cons of having a young adult be in control of their own account vs. having a trustworthy person that the owner is comfortable with in control of the account.
529 account mistakes can be avoided!
Choosing a 529 account successor and beneficiary can be complicated. If you are considering a 529 account and have questions, please reach out to us to talk.
Andrew Hoffarth, CFP® is a Lead Advisor with Financial Alternatives. When he’s not enjoying outdoor activities with his family, he excels at finding solutions for complex financial situations, allowing successful families to focus on what is most important to them. Schedule a time to chat with Andrew.
