When is transfer of ownership of a 529 account a taxable event?

Paying for College
1

I’m trying to research this issue online and not getting anywhere.

I know that the transfer of ownership from one spouse to another spouse that is part of a divorce settlement is not a taxable event. I know that because ex-husband and I did that when we got divorced a few years ago. But what about other transfers, such as to the other parent after divorce? Or to the beneficiary? Or one generation up, to a grandparent?

Again, I’m looking for information about transfer of ownership, not changing the beneficiary.

Does anyone know if the IRS has issued rules on this? I have inquired to the agency that administers Ohio 529 plans, the Ohio Tuititon Trust Authority. If I get good information from them, I will post here. My fear is that 529s are fairly new, and the rules haven’t really been established for unusual situtations yet. From a tax perspective 529s are odd, with some characteristics of a completed gift to the beneficiary and some characteristics of an asset of the account owner.

The reason I’m interested is because my ex-husb and I funded 529s for both our kids when they were little, but son now has schizophrenia and can’t go to college. We want to take the money out of son’s 529 to buy him a condo, but that will mean paying 10% penalty and income tax on all those capital gains – ugh. There are a lot of gains, because 529s were funded when kids were very little. Son is in zero tax bracket, so making withdrawals payable to him is tax-advantageous, but we’re wary of doing that because he can’t manage money. The grandparents are in lower tax brackets than myself and ex-husb, but I haven’t discovered yet what the tax consequences of transferring to them would be. Also, daughter will be attending college starting 2018, so any withdrawals from son’s 529 payable to me will increase my income and potentially reduce need-based aid for daughter.

Frankly, son needs help from his parents far more than daughter needs elite education at a private college. Bright, hard-working girls like my daughter never end up homeless. Schizophrenic young men like my son without family support end up homeless all the time. That’s why we don’t want to name daughter as the beneficiary of son’s 529s and let her use the money we saved for him.

2

I don’t know if there is a workaround on the taxes but I believe the penalty is waived if the beneficiary of the account (your son) is disabled and unable to attend college.

You might want to find a lawyer in your state who specializes in financial planning for kids with disabilities, adults with long term care needs, setting up trusts, etc. If your son can’t manage money, there may be better vehicles to help take care of him than just buying him a condo outright (like transferring the 529 money into a trust).

Hugs to you.

3

Yes, there is a waiver of the penalty for disability. See page 60 of IRS Publication 970. Also, here’s a link from savingforcollege.com that references this -
http://www.savingforcollege.com/questions-answers/article.php?article_id=20

4

From IRS Pub 970:

*Exceptions. The 10% additional tax doesn’t apply to the following distributions.
…

  1. Made because the designated beneficiary is disabled. A person is considered to be disabled if he or she shows proof that he or she can't do any substantial gainful activity because of his or her physical or mental condition. A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration.

…*

As to your question in the thread title:

I haven’t heard what I consider to be a definitive answer to this question, but I don’t think there is any tax issue with regards to the ownership transfer of a 529 account. In the eyes of the tax law, the contributed funds in the account are deemed to be a gift to the designated beneficiary as soon as a deposit is made to the account, even though the account owner retains control of the money and can use it for something that doesn’t benefit the beneficiary (subject to income tax and a 10% penalty on the earnings portion of any non-qualified distribution).