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Planning for the future and investing in education are top priorities for many families. The 529 plan is a powerful tool for saving for college or other educational expenses, offering tax-free growth and withdrawals when used for qualified expenses.
But what happens when circumstances shift, and you want to change the 529 plan beneficiary from one family member to another? Specifically, if you’re considering changing the beneficiary from your child to your grandchild, there are unique tax implications to consider, including potential gift and generation-skipping transfer (GST) taxes.
Here’s what you need to know to ensure a smooth transition with minimal tax impact.
Understanding 529 Plans and Gift Tax Basics
Contributions to a 529 plan are technically considered gifts for tax purposes. In 2024, the annual gift tax exclusion amount allows up to $18,000 per recipient without triggering any gift tax. For married couples, this amount doubles to $36,000 if they elect gift splitting. Any amount that exceeds the annual exclusion will count toward the lifetime gift tax exemption, which currently stands at $13.61 million.
These exclusions play a critical role when changing the beneficiary on a 529 plan, as this can be treated as a “gift” from the original beneficiary (your child) to the new one (your grandchild) if the two are not in the same generation. That’s where the potential for gift tax arises.
Changing Beneficiaries: What’s the Impact?
When changing a 529 plan beneficiary to a grandchild, the IRS may interpret this as a gift transfer, which has tax implications based on generational relationships:
- Same Generation Transfers: When a 529 plan beneficiary change happens between individuals of the same generation (like from one sibling to another), the IRS typically doesn’t consider it a taxable event. As long as the funds are used for qualified educational expenses, the change is seamless.
- Generation-Skipping Transfers: When the change is between generations — such as from a child to a grandchild — the IRS sees it as a generation-skipping transfer. This designation could trigger either gift tax or GST tax if the amount exceeds the annual gift tax exclusion.
Navigating Gift Tax Implications
If the balance in the 529 plan is at or below the annual exclusion amount of $18,000, there’s no need to file a gift tax return (Form 709), and you won’t face any gift tax. However, if the account balance exceeds this amount, the excess will be applied toward the original beneficiary’s lifetime gift tax exemption. It’s worth noting that while a gift tax return will be required in this case, no actual tax is due unless the lifetime exemption is exhausted.
To further mitigate any potential tax liabilities, families may opt for a five-year gift tax election, a unique provision for 529 plans that allows “front-loading” contributions across five years without affecting the lifetime gift tax exemption. This election enables individuals to contribute (or transfer) up to $90,000 — or $180,000 for married couples — over five years without tax consequences. It’s a beneficial strategy for high-net-worth individuals who are looking to maximize contributions while minimizing tax impacts.
Other Options: 529 Plan Rollover to Roth IRA
If changing the beneficiary brings up tax concerns, another option is rolling over unused 529 funds into a Roth IRA. Starting in 2024, this rollover can be tax-free and penalty-free if certain conditions are met, making it a compelling alternative for those who wish to repurpose 529 savings.
Read more here about the 529-to-Roth rollover rules and eligibility.
What About GST Tax?
The generation-skipping transfer tax (GST) is an additional tax that applies to large gifts made to grandchildren or individuals two or more generations below the original beneficiary. The GST exemption mirrors the lifetime gift tax exemption of $13.61 million per individual, meaning only large transfers would trigger this tax. Most families will not encounter the GST tax, but for high-balance accounts, it’s wise to monitor this threshold.
Tax-Free Growth Continues with Qualified Use
One of the major benefits of the 529 plan is that it remains tax-free as long as the funds are ultimately used for qualified educational expenses. Changing the beneficiary alone does not impact this tax-free growth, nor does it trigger income taxes or penalties. Penalties only arise if the funds are withdrawn for non-qualified expenses. As a result, even with beneficiary changes, the original purpose of funding education can be preserved tax-efficiently.
Let’s Review: The Key Points to Consider
- Gift Tax: Transfers within the same generation typically have no tax implications, while generation-skipping transfers, such as from child to grandchild, may trigger gift tax filing if the balance exceeds $18,000.
- GST Tax: Not applicable for most families unless they are transferring substantial funds.
- Five-Year Election: For those looking to make a significant transfer, the five-year election allows contributions to be spread across five years, providing flexibility with no gift tax impact.
When considering a change from a child to a grandchild as the 529 plan beneficiary, being aware of these rules can save both taxes and hassle. For families with higher balances, it may be wise to consult with a tax professional to maximize the benefits of a 529 plan while navigating the intricacies of gift and GST tax.
With the right approach, a 529 plan remains one of the most effective ways to secure your family’s educational future.
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