How to Transfer 529 Funds From One Family Member To Another

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529 plans, or Qualified Tuition Programs as the federal government calls them, are specialized investment accounts to give tax-advantaged savings for education expenses. 529 plans are typically the best vehicle to save for college. Thanks to the 2018 Tax Cuts and Jobs Act, you can now also reimburse yourself up to $10,000 for elementary or secondary school tuition.

Contributions to a Virginia 529 plan offer the account owner a Virginia state tax deduction. Then, distributions to reimburse for any qualified education expenses are distributed both state and federal tax-free.

When a 529 plan is set up, there are two important people associated with the account. The first is the account owner and the second is the beneficiary.

Regardless of who contributes, the account owner is the individual who receives the state tax deduction. Although you might think that the beneficiary is a fixed feature of the account, who the beneficiary is can actually be quite fluid. The account owner can change the beneficiary at will, normally with a bit of paperwork. The account owner can also perform a 529 rollover, transferring funds from one beneficiary’s account to another beneficiary’s account.

There are several reasons why you might want to give funds to a different beneficiary. For example, if your oldest finishes college with leftover funds, you may want to simply contribute them to their younger sibling. Or if your oldest children’s 529 accounts received grandparent or great-grandparent assistance, while your caboose child did not get that benefit, you may want to even up the pots.

A more complex case may be that you want to put funds back into a 529 plan without penalty by turning the distribution into a rollover contribution, as is the case when you are trying to correct disbursements after a child drops out from college.

Although you are permitted to perform rollovers by IRS code, College America will only let you change the beneficiary on an account. They either will not let you or are extremely hesitant to let you rollover funds between accounts. For this reason, to actually change a beneficiary at College America, the easiest way is to use the College America Account Change Request to name a new beneficiary.

Here’s a more complete look at 529 rollovers, the tax rules that govern them, and practically how to implement the transfer.

US Code 529(c)(3) states in part:

(A) In general

Any distribution under a qualified tuition program shall be includible in the gross income of the distributee in the manner as provided under section 72 to the extent not excluded from gross income under any other provision of this chapter.

(C) Change in beneficiaries or programs
(i) Rollovers

Subparagraph (A) shall not apply to that portion of any distribution which, within 60 days of such distribution, is transferred—

(I) to another qualified tuition program for the benefit of the designated beneficiary,
(II) to the credit of another designated beneficiary under a qualified tuition program who is a member of the family of the designated beneficiary with respect to which the distribution was made, or
(III) before January 1, 2026, to an ABLE account (as defined in section 529A(e)(6)) of the designated beneficiary or a member of the family of the designated beneficiary.

Subclause (III) shall not apply to so much of a distribution which, when added to all other contributions made to the ABLE account for the taxable year, exceeds the limitation under section 529A(b)(2)(B)(i).

(ii) Change in designated beneficiaries

Any change in the designated beneficiary of an interest in a qualified tuition program shall not be treated as a distribution for purposes of subparagraph (A) if the new beneficiary is a member of the family of the old beneficiary.

This means you can use a 529 rollover to change account owners or custodians or to change beneficiaries to a different family member without having the rollover distribution included in taxable income.

There is one exception given later in the same code section, which reads:

(5) Other gift tax rules

For purposes of chapters 12 and 13—
(A) Treatment of distributions

Except as provided in subparagraph (B), in no event shall a distribution from a qualified tuition program be treated as a taxable gift.

(B) Treatment of designation of new beneficiary The taxes imposed by chapters 12 and 13 shall apply to a transfer by reason of a change in the designated beneficiary under the program (or a rollover to the account of a new beneficiary) unless the new beneficiary is—

(i) assigned to the same generation as (or a higher generation than) the old beneficiary (determined in accordance with section 2651), and
(ii) a member of the family of the old beneficiary.

If you are transferring to a beneficiary that is not family or is not a higher or the same generation as the previous beneficiary, then the taxes of Chapter 12 (Gift Tax) and 13 (Generation-Skipping Transfer Tax) may apply.

Most people are unaware that giving a gift can be a taxable event because they themselves have not yet experienced the tax. However, some very generous people do face this unusual tax.

The reason we have a gift tax is because we have an estate tax. If there was no gift tax, then when someone with a large estate knew they were dying, they could give nearly all their money away, reducing their estate to a non-taxable level and dodge the estate tax. The government does not like this scenario, so they created a gift tax to stop it.

The good news is that the IRS only taxes gifts after a certain threshold. Currently for 2018, 2019, and 2020, the annual exclusion is $15,000. One individual can give up to this limit to another individual without it being a taxable event or requiring any reporting. If you do give over the limit to one person in one year, only the amount you went over is taxable.

For married couples, each spouse can give up to the the limit per recipient tax-free. As a couple in 2020, this means you can give $30,000 ($15K each) to one person without running into gift tax problems.

The Generation-Skipping Transfer Tax kicks in when you make a taxable gift (over the limit) to a single related individual more than one generation younger than you. This is most commonly a gift from grandparents to grandchildren. This generation-skipping transfer tax or (GST) is in addition to the gift taxes that are owed on the gift.

Generation-Skipping Transfer tax and gift tax are added together to create your tax bill.

GST is always taxed at 40% in Form 709 Schedule D Part 3 Column F. Gift tax is calculated using the following table from the Form 709 instructions:

Table for Computing Gift Tax

Column A Column B Column C Column D
Taxable
amount
over—
Taxable
amount
not over—
Tax on
amount in
column A
Rate of tax
on excess
over amount
in column A
– – – – – $10,000 – – – – – 18%
$10,000 20,000 $1,800 20%
20,000 40,000 3,800 22%
40,000 60,000 8,200 24%
60,000 80,000 13,000 26%
80,000 100,000 18,200 28%
100,000 150,000 23,800 30%
150,000 250,000 38,800 32%
250,000 500,000 70,800 34%
500,000 750,000 155,800 37%
750,000 1,000,000 248,300 39%
1,000,000 – – – – – 345,800 40%

For the purposes of this section, family is defined as follows:

(2) Member of family

The term “member of the family” means, with respect to any designated beneficiary—
(A) the spouse of such beneficiary;
(B) an individual who bears a relationship to such beneficiary which is described in subparagraphs (A) through (G) of section 152(d)(2);
(C) the spouse of any individual described in subparagraph (B); and
(D) any first cousin of such beneficiary.

The referenced 152(d)(2) A through G are:

(A) A child or a descendant of a child.
(B) A brother, sister, stepbrother, or stepsister.
(C) The father or mother, or an ancestor of either.
(D) A stepfather or stepmother.
(E) A son or daughter of a brother or sister of the taxpayer.
(F) A brother or sister of the father or mother of the taxpayer.
(G) A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.

For this reason, you can liberally and freely change beneficiaries from within one family on the same generational line almost as far as you have family tree. You can also transfer up the family tree. However, if you want to transfer down a family tree more than the current gifting limits, you can run into taxation problems.

Photo by Jude Beck on Unsplash

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Chief Operating Officer, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. Her most popular post: The Complete Guide to Your Washing Machine