Arcane Rule Question About 529 Beneficiaries

[FlaGator]

I am the successor owner of my late mother's 529 accounts opened for her great-grands (my sister's GKs, I am the great uncle). I will soon hand them over to them to my sister to manage.

But while they are in my control, I would like to transfer a portion of my kids' over-funded balances to each of them.

As I read the IRS rules on transfers to different a different beneficiary, I'm not sure this fits their stated definition of family. These kids are the children of my beneficiaries first cousins, and that looks one step removed from what is permitted. However, the plan sponsor (NYSaves) told me I could make the transfers.

I know I could set up an account for my sister and she could then transfer to her GKs, but I prefer to make this as simple as possible while being compliant.

Does anyone experience or guidance on this?
Thanks!

 

[SecondCor521]

I read through the tax laws and it does seem your understanding is correct.

It does seem that you could do it legally in two steps: first from your kids to your sister and then to her GKs. Another similar approach is to transfer from your kids to their first cousin who is a parent of the destination GKs and then to the GKs.

While technically illegal, I would be surprised if the IRS would get too worked up about it if you chose to do it in one step instead of going through the bother and hassle of opening up the intermediate 529s just for the purposes of complying with the technicalities of the law, just to close them after the transfers are complete. But I don't have direct experience with the IRS, so I could be off base.

NYSaves is technically accurate - you can transfer 529 funds from any one person to any other person. But transfers that don't meet that technical definition of family members would be included in gross income (i.e., be taxable) to the distributee, which I believe in this case would be the GKs.

As long as we're talking arcane, one other thing to consider is that it's possible that your suggested transfer would be subject to gift tax if over the $18K annual gift exclusion amount. This Kitces article discusses it: Dynasty 529 Plan For Multigenerational College Expenses. So your kids might have to file a gift tax form (the Kitces article asserts that the gift would be treated as being from your kids even though you're the one making the transfers).

 

[FlaGator]

I read through the tax laws and it does seem your understanding is correct.

It does seem that you could do it legally in two steps: first from your kids to your sister and then to her GKs. Another similar approach is to transfer from your kids to their first cousin who is a parent of the destination GKs and then to the GKs.

While technically illegal, I would be surprised if the IRS would get too worked up about it if you chose to do it in one step instead of going through the bother and hassle of opening up the intermediate 529s just for the purposes of complying with the technicalities of the law, just to close them after the transfers are complete. But I don't have direct experience with the IRS, so I could be off base.

NYSaves is technically accurate - you can transfer 529 funds from any one person to any other person. But transfers that don't meet that technical definition of family members would be included in gross income (i.e., be taxable) to the distributee, which I believe in this case would be the GKs.

As long as we're talking arcane, one other thing to consider is that it's possible that your suggested transfer would be subject to gift tax if over the $18K annual gift exclusion amount. This Kitces article discusses it: Dynasty 529 Plan For Multigenerational College Expenses. So your kids might have to file a gift tax form (the Kitces article asserts that the gift would be treated as being from your kids even though you're the one making the transfers).

Thank you for looking at this. Reassuring to know someone with your knowledge and experience believes I haven't mis-interpreted anything.

Agree the likelihood of this ever getting flagged and questioned is small. The total amount I'm considering is below the gift tax threshold, but enough to be meaningful as the ultimate beneficiaries are all <5 years old. And my contribution is a gift, it's up to that branch of the family to deal with college expenses.

I think the safe thing to do is open an account for my sister and put the total amount in her account. Then we can do the transfers to the kids and later hand over control to her.

Thanks again!