05 Mar When a 529 Plan beneficiary dies

 Q. My wife has saved in a 529 Plan for her nephew, but he died at age 11, long before he could use the money his aunt had been saving. How does my wife gain access to the money without penalty? Can she transfer the money to some other retirement account for herself?

A. We’re very sorry to hear about your wife’s nephew.

If the beneficiary of a 529 account dies, the account owner can change the beneficiary on the account to another member of the beneficiary’s family or request a non-qualified withdrawal, said Sheri Iannetta Cupo, a certified financial planner with SageBroadview in Morristown.

“For this type of non-qualified withdrawal, the earnings portion will be subject to federal and state income taxes but will be exempt from the 10 percent federal tax penalty,” Cupo said.

Those whose beneficiary is disabled, or has received a scholarship, can also withdraw the money without penalty — but the taxes are still due.

In most other cases, the 10 percent penalty would be owed.

If you decided to switch the account to a different beneficiary, the change could be made to a spouse or these relatives:

1. Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them.
2. Brother, sister, stepbrother, or stepsister.
3. Father or mother or ancestor of either.
4. Stepfather or stepmother.
5. Son or daughter of a brother or sister.
6. Brother or sister of father or mother.
7. Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
8. The spouse of any individual listed above.
9. First cousin.

“Money from the non-qualified withdrawal could be used however you wish and could potentially fund a retirement benefit for your wife, but such funding would be subject to the rules and requirements for the retirement plan you are funding,” Cupo said.

You should calculate the possible taxes owed before you make any moves.

“The institution where the funds are located should have the current value and the amount of the contribution (a.k.a. cost basis) of the account,” said Peter McKenna, a certified financial planner with Highland Financial in Riverdale. “The difference between the current value and the cost is the amount that would be subject to tax.”

He said the withdrawal will be taxable at ordinary income tax rates.

If you have timing flexibility, McKenna said it may make sense to hold off on the non-qualified withdrawal until you are in a lower tax bracket, potentially in retirement.

“By delaying, the amount in the account can grow tax-deferred until it is withdrawn,” he said.

You should also consider the costs you bear on the 529 account. If those costs are higher than you can do outside of the 529, much of the tax-deferral benefit will be lost to costs, McKenna said.

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This story was first posted in March 2015.