OPTIONS WHEN THE BENEFICIARY DOES NOT
USE UP THE SECTION 529 ACCOUNT
Recognizing that some beneficiaries will choose not to pursue higher education, Congress included provisions in Section 529 that will permit the account owner a certain degree of flexibility in changing the designated beneficiary to another individual without suffering adverse tax consequences.
 | Income Tax Effects of Changing Designated Beneficiaries |
Federal law provides that any change in the designated beneficiary of an interest in a Section 529 Plan will not be treated as a taxable distribution if the new beneficiary is a "member of the family" of the old beneficiary.
| Family Members |
"Member of the family" is defined to mean, with respect to the designated beneficiary – not the account owner – his or her:
| Spouse of designated beneficiary |
| Son or daughter, or a descendant of either |
| Stepson or stepdaughter |
| Brother, sister, stepbrother, or stepsister |
| Father or mother, or an ancestor of either |
| Stepfather or stepmother |
| Cousin |
| Son or daughter of a brother or sister |
| Brother or sister of the father or mother |
| Son-in-law or daughter-in-law |
| Father-in-law or mother-in-law |
| Brother-in-law or sister-in-law |
| Spouse of any family member described above |
| First Cousins |
Federal law includes "any first cousin" of the beneficiary as a "member of the family." This will allow a grandparent to change the beneficiary from one grandchild to the other without adverse tax consequences, when the grandchildren are not born of the same child of the grandparent.
| Relatives Not Included |
Even under the expanded definitions, "member of the family" still does not include a beneficiary’s grandniece or grandnephew, the descendant of a stepchild, or a spouse's niece or nephew.
| Gift Tax Effect of Change of Designated Beneficiary or Rollover |
A transfer that occurs by reason of a change in the designated beneficiary, or a rollover of credits or account balances from one beneficiary’s account to another’s, will not be treated as a taxable gift if the new beneficiary is a member of the family of the old beneficiary, and is assigned to the same generation as the old beneficiary.
However, if the new beneficiary is assigned to a generation lower than the old beneficiary, regardless of whether the new beneficiary is a member of the family of the old beneficiary, a taxable gift will be deemed to be made from the old beneficiary to the new beneficiary.
| GST Tax Effects of Change of Designated Beneficiary or Rollover |
IRC Section 72 annuity rules will not apply to that portion of any distribution which, within 60 days of such distribution, is transferred to the credit of another designated beneficiary under a Section 529 Plan who is a member of the family of the designated beneficiary with respect to which the distribution was made.
As described above in connection with the federal gift tax, under federal law a transfer that occurs by reason of a change in the designated beneficiary will be subject to generation-skipping transfer tax if the new beneficiary is assigned to a generation that is two or more levels lower than the generation assignment of the old beneficiary. In such event, the five year averaging rule may be applied to the transfer.
