Can You Make An Unborn Grandkid Beneficiary For An Overfunded 529?

crispydoc Uncategorized 9 Comments

[Every now and then bloggers with the best of aims write a post that confuses their readers. This is my public embarrassment. I've tried to clarify the points in a subsequent post you can find here. Please forgive me if I paved your road to confusion with my good intentions. I'll let this post remain as a reminder of my failure so I don't repeat it.]

I've been a fanboy of CPA Mike Piper's blog, The Oblivious Investor, for many years, so when he wrote a post about changing the beneficiary on a 529 plan I looked forward to learning something.

Like most docs, when I opened a 529 I was a sleep-deprived new dad trying to do the right thing for my kid. Since California did not offer tax incentives for contributing to a 529, I was doing it because I was told it was the thing to do by people older or smarter than I was at the time.

Some of those people perpetuated an urban legend of sorts: we could always fund our children's 529 plans maximally, and if our kids did not use all of the money, take advantage of decades of compounding by changing the beneficiaries to our theoretical, as yet non-existent grandchildren once they were born.

We opened 529 plans within months of starting a family, and funded them as generously as we were able for many years during which we kept our noses to the grindstone, saved up, and bought a home. This pattern stopped several years later after my in-laws informed us that they, too, were funding a 529 for each of our kids.

We decided to pivot from adding to 529 accounts to instead augmenting our taxable brokerage investments for increased flexibility in how we spend the money, since there are stiff penalties for using 529 money for anything other than qualifying educational costs.

The penalties to the account owner include charging income tax on the earnings in addition to a 10% penalty. That's an expensive moron tax to pay for overfunding a 529. The objective is to ensure you pay more in taxes if you overfund a 529 and then use the money for non-qualified educational expenses than if you had just saved it up in a taxable brokerage account in the first place.

So what about the urban legend? If the stars align and the grandparent 529s end up holding enough to fund our kids' educations, could we theoretically leave the money in the 529s we funded to compound for decades and then change the beneficiaries to grandchildren that do not yet exist without incurring additional tax liability?

To understand the law, I began by attempting to read it. Mike had conveniently linked to the letter of the law in his post.

I scrolled through until I found what appeared to be the pertinent section:

(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—


assigned to the same generation as (or a higher generation than) the old beneficiary (determined in accordance with section 2651), and


a member of the family of the old beneficiary.

Let me qualify what follows by stating unequivocally that doctors make lousy lawyers, and it would be terrible judgment to mistake some guy's post on the interwebs as reliable legal advice.

So section B above implies that the gift tax and generation skipping tax apply unless you meet the criteria in both (i) and (ii). Got it.

Mike's original post did a better job than I can of explaining what constitutes a member of the family in subsection (ii) above; his summary is here.

I tried reading section 2651 referred to in subsection (i), and found it answered my question explicitly - it limits the change in beneficiary to the same generation as the original beneficiary.

No, we cannot overfund our child's 529 plan and then change the beneficiary to that child's as yet unborn grandchild at some future date. We can, however, designate that grandchild the new beneficiary after it is born.

A beneficiary needs to be an actual, existing person with a social security number. So said grandchild needs to be in existence.

You can absolutely change the beneficiary to a subsequent generation - it just exposes you to potential tax liabilities, which you presumably intended to legally avoid by opening a 529 in the first place.

Let's explore this through two examples.

  • You are a future parent and you open a 529 in your own name, then have a child, then change the beneficiary to your child.
    • You are not subject to the generation skipping tax because the new beneficiary is only one generation removed from the prior beneficiary.
    • As account owner, you face no tax liability. As former beneficiary, you are regarded as giving a gift under federal gift tax. You may be taxed on that gift if it exceeds limits ($15k per year in 2020, or a single gift of up to $75k over a 5 year period).
  • You are a future grandparent and you open a 529 in your child's name, then (decades later) that child sires your grandchild, and you change the beneficiary to your grandchild.
    • You are not subject to the generation skipping tax because the new beneficiary is only one generation removed from the prior beneficiary.
    • As account owner, you face no tax liability. As former beneficiary, your child is regarded as giving a gift under federal gift tax. Your child may be taxed on that gift if it exceeds limits ($15k per year in 2020, or a single gift of up to $75k over a 5 year period), but the tax penalty your child faces won't amount to anything of consequence.

Gift tax liability should not be a significant consideration for the vast majority of physicians. This is because the tax is levied against your estate at the time of your demise, and is only levied if gifts exceed current estate tax limits (~$11.5 million per individual, ~$23 million per married couple).

So in the second example, if your child's 529 worth $100k names your grandchild as the new beneficiary, your child is required to file paperwork noting the $85k excess above the $15k tax free limit with his tax filings in the tax year that the gift is made. Then, when your son dies, the tax free amount he can leave to your grandson is $11.5 million minus $85k. So the theoretical tax liability is not much of a concern in practice.

See this outstanding post from Wealthy Mom MD for a better understanding of the gift tax.

Alternate Strategies

As an aside, I found it fascinating how legislators must imagine every conceivable scenario in advance in order to decide how it fares under the law. It increased my respect for the job at a moment when I have not felt the greatest respect for many of those who occupy it.

Although 529s cannot have their beneficiaries changed to subsequent generations without assuming the risk of incurring tax liability, looking into this question brought me to articles touting section 2503(e) of the Internal Revenue code.

That code permits a grandparent who already made the maximum tax-free gift allowable under the law to a grandchild to additionally make tax-free payments directly to an educational organization on behalf of the same grandchild if it covers tuition only.

One could envision a three-legged strategy for paying for college for a grandchild:

  1. Funding tuition under section 2503(e) with direct transfers to qualifying educational organizations
  2. Contributing a lesser amount over the years to a 529 plan and using that to fund all qualifying non-tuition college costs
  3. Liquidating a taxable brokerage fund and then gifting the maximum tax-free gift allowable allowable to make up for any shortfall

There are obvious weaknesses to this strategy - it requires you as grandparent to be alive when your grandchild starts college and remain alive until they graduate, something that is beyond your control (if also nicely aligned with your incentives).

Curious if your grandchild's yoga class, martial arts classes or wilderness survival curriculum might qualify for using this benefit? Read here to go deeper into the weeds.

Comments 9

  1. The enemy of good is better. Funding a 529 to the max whether a parent or grandparent has only one optimal result, the beneficiary children need all of it. If not, you end up trying to figure out how to get the rest out without paying extra to Uncle Sam. Balancing the 529 with a taxable account gives you flexibility for an unknown future. For my two kids we funded 529s up to two years of in-state costs and saved more in separate taxable accounts earmarked for each. Neither used all of their funds but both used all of the 529s so now we have a source for adult giving.

    1. Post

      Well-conceived compromise, GasFIRE – I’m impressed you had the presence of mind to envision and execute it at the outset.

      In our case, we reacted after the fact but are probably overfunded.

      The cultural discomfort with talking about money made it more difficult to identify the redundancy in funding. Interesting aside, since that time I’ve grown far more comfortable talking money with both parents and in-laws, and while I don’t share much in the way of specifics of our income, they’ve started to seek out my advice on financial matters as it pertains to generational wealth transfer (especially since the SECURE act passed).

  2. So… based on this, from what I understand… you can only change the beneficiary to a sibling (same generation, same family)? Wow, I didn’t know it was that strict.

    To be fair, I have not researched much of this at all. At one point I did think about opening a 529 when my daughter was born. But then I shelved that idea and decided to fund a taxable account instead as a PSLF insurance side fund.

    1. Post

      It extends further to include nephews, adopted kids, and the concept of same generation is made quite explicit. It’s worth reading Mike’s post to see the full definition of “family.”

      The generation skipping tax is the sticking point. Most docs I know are oblivious to this tax penalty until well after they overfund the 529.

      You’ll do fine by paying for her education with the side fund instead of a 529. Alternately, funding 2 years of college with 529 contributions might be be a reasonable compromise to get the tax benefits if you are willing to risk give up flexibility.

  3. I think 529’s are a rip off. They are funds designed to annuitize colleges, and as such are a pre-determined fleecing of parents. They operate similar to the time share industry. You buy some “thing” which is supposed to be a college education, but in fact what you do is silo your money and give ownership to colleges. That money becomes theirs, it is no longer yours because the penalty for withdrawal is too great both monetarily and psychologically. It costs you a quarter on every dollar to get your money back and jr still needs an education. The money is siloed in a way that it basically can ONLY be spent at the college. It is in funds that produce about 6% return, and guess what the inflation of the cost of education is, about 6%. So the colleges own the money and controls the rate of inflation and that assures they hoover up every last dollar you set aside. Throw your money in the 529 and wave bye bye. Jr decides to become a plumber, wave bye bye to whatever money that 100K could have returned over 25 years.

    In my case I bought a prepaid 120 hours with all fees and housing at any state school in my state at age 1. This way if I croaked school was paid for. I then funded a UGTM with efficient funds and stocks like BRK.B that threw off little tax consequence and let that grow. At 18 the UGTM became the kids, and so I spent every cent for the benefit of the kid. Need a trip to Europe? Get some dough out of the UGTM. Need to spend a few hundred on clothes? Get some dough out of the UGTM. Vaca in Cali? UGTM buys the ticket. Graduate college and need a car? The UGTM bought that too. I ran it like my retirement account selling down assets only as needed per semester which kept cap gains low to zero. I made too much money to get any real tax break on the kid compared to the expense, so I just minimized the tax exposure. The best part was I could retire in the middle of 2 kids in college and it didn’t nail my cash flow at all.

    1. Post

      That’s a much more realistic frame of reference – how eager should you be to commit a chunk of change to college exclusively? Rings especially true in places like California, where there is less tax incentive to contribute.

      Taxable makes much more sense, especially seeing how it played out for your daughters.

  4. Oh, man. That’s not cool. I’ve read and repeated that the money could used for future generations, but it appears I’ve got some editing and thinking to do. With two six-figure 529 Plans and years to go before college, do we continue funding them?

    Pretty lame that I’ll be penalized for having a small family.

    Thank you for the deep dive — I’ll be reading Mike Piper’s post, as well.



      I just went and read Mike Piper’s post, and I’m relieved. No editing or apologies are necessary.

      “There, we find that there are no income tax consequences to changing the beneficiary of a 529 account, provided that you change the beneficiary to somebody who is a “member of the family” of the existing beneficiary. Members of the family include:

      A child or a descendant of a child (i.e., a grandchild);
      A brother, sister, stepbrother, or stepsister;
      The father or mother, or an ancestor of either (i.e, grandparent);
      A stepfather or stepmother;
      A niece or nephew;
      An aunt or uncle;
      A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law;
      An individual who, for the taxable year of the beneficiary, has the same principal place of abode as the beneficiary and is a member of the beneficiary’s household;
      The spouse of any of the above people;
      The spouse of the existing beneficiary; or
      A first cousin of the existing beneficiary.”

      I now realize you are only talking about UNBORN grandchildren.

      But the beneficiary can absolutely be changed to future grandchildren, just not until they’re actually alive. But you don’t have to wait until they’re in college.

      And you may want to edit or qualify this statement above: “Although 529s cannot have their beneficiaries changed to subsequent generations…”

      They can as long as the generation exists.

      You had me worried for a bit there!

      1. Post


        Just returned from a retreat and read this.

        Instead of posing my question as whether you could designate an unborn grandchild the new beneficiary, a better way to phrase my question might have been:

        Can my dad (account owner) change an overfunded 529 opened in my name (originally for my benefit) to my son without sustaining any tax liability?

        If the new beneficiary is only one generation “below” the prior beneficiary (i.e., changing from me to my son) and I am not the account owner (in case above, my dad is account owner) then changing the beneficiary from me to my son is not subject to the GST.

        It is, however, considered a gift from me to my son and is subject to the federal gift tax restrictions. Not a big deal if the amount is $14k or less. Can even work around it by super-funding a single large gift of $75k once during a five year period since federal law permits 5-year gift tax averaging. But if you have let it ride and are talking $200k, that means I could potentially get saddled with a large gift tax bill if I change the beneficiary to my son.

        Here are two additional articles I found useful:

        How the Generation Skipping Tax (GST) applies to 529 contributions from grandparent to grandchild, here.

        How the generation of the changed beneficiary determines whether or not the federal gift tax applies, here.

        Yes, Virginia, your son’s 529 can be used for later generations – but your son may be subject to gift tax penalty if you are the account holder and the beneficiary is changing to your grandchild.

        Hope this helps, and please let me know if I got it wrong – it would be far better for all of us if I overlooked something.

        Thanks for keeping me honest,


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