A 529 plan beneficiary can be changed to a qualifying member of the family of the current beneficiary at any time. This flexibility may help families avoid paying taxes and penalties on unused 529 plan funds and can be used as a strategy to avoid limitations around 529 plan rollovers and investment options.
Here are several reasons why a family might consider changing their 529 plan beneficiary.
You have leftover funds in a 529 plan
If a child decides not to go to college or chooses to attend a less expensive college, they may end up with leftover funds in a 529 plan. A family can withdraw the leftover funds, but the earnings portion of non-qualified distributions are subject to income tax and a 10% penalty, as well as recapture of state income tax breaks.
To avoid taxes and penalties, the parents can change the 529 plan beneficiary to a qualifying family member of the beneficiary who will attend college. Up to $10,000 per year can also be withdrawn tax-free from a 529 plan to pay for K-12 tuition expenses for the new beneficiary.
You want to transfer 529 plan funds to a sibling
Some families use a single 529 plan to save for more than one child’s future college education. However, a 529 plan can have only one designated beneficiary at a time. Distributions used to pay for college expenses of the beneficiary’s sibling will be considered non-qualified.
You may transfer 529 plan funds to a sibling tax-free by changing the beneficiary on the current 529 plan or rolling the funds into a sibling’s existing 529 plan.
In most cases it is best to have a separate 529 plan for each child. Having separate 529 plans will allow parents to tailor a customized investment strategy for each child and keep better track of their savings goals.
You started saving for college before your child was born
Expecting parents can get a head start on college savings by opening a 529 plan account before their child is born. However, an unborn child cannot be a 529 plan beneficiary. One of the parents must name themselves the beneficiary and change the beneficiary to the child once the child has a Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN).
The sooner parents start to save in a 529 plan, the more time they have to take advantage of potential earnings growth from tax-free compounding. Friends and family may also want to contribute to a newborn’s 529 plan instead of giving a traditional baby shower gift.
You want to change investments more than twice during a calendar year
529 plan account owners may change 529 plan investment options twice per calendar year. However, there is an exception to this rule when the investment change is submitted with a beneficiary change request.
The beneficiary can be changed to the current beneficiary’s sibling or parent and changed back once the investment change is completed.
Keep in mind that the investment change rule applies to existing contributions. 529 plan account owners can always select a different investment option for new 529 plan contributions.
You want to switch 529 plans more than once during a 12-month period
If a 529 plan isn’t meeting a family’s needs, the family may consider rolling the funds into a new 529 plan that offers lower fees, better investment performance or additional state tax benefits. 529 plan account owners are limited to one tax-free 529 plan rollover per 12-month period. But, families can get around this rule by changing 529 plan beneficiaries.
529 plan account owners may designate a qualifying member of the beneficiary’s family as the beneficiary of the 529 plan they are switching to. When there is a new beneficiary, the rollover will not count toward the once per 12-month limit.