Plus, answers on beneficiary changes within the family and using 529s to pay off student loans.
Question 1: We have a client who established a 529 plan account at Fidelity where he is the owner and a grandchild is the beneficiary. The client is failing, and it is hard to get him to write the checks to pay for school on time. Client's son, beneficiary's father, wants to be made the new owner on the account so that he can write the checks instead of having to try to get the check written by our client. Client agrees and will sign paperwork making son the new owner on the account. Fidelity says that if we do this, we'll be treated as taking everything out of the account and be subject to income tax and the 10% penalty.
Answer: There is no authority on whether a change of an account owner should be treated as a nonqualified distribution of the account followed by a new gift. In my view, a change of account owner should not have any tax consequences (unless it was done abusively) because Code section 529 treated the original contribution to the account as a completed gift to the beneficiary, and a change of account owner does not change the beneficiary of the account. (An example of an abusive change of account owner would be if the account owner was changed to the client's son, who promptly withdrew the funds and kept them himself.) Fidelity is obviously taking the most conservative view in how it reports a change of account owner and leaving it up to the taxpayer to explain to the IRS why there should be no tax.
So what do you do in this situation? The best answer may be to have the client sign a Power of Attorney over the 529 account naming the son as agent and giving the son the power to take actions with respect to the account. I would suggest using the program's 529 power of attorney (if it has one), which the program may more readily accept than a separate general or durable power of attorney. In fact, if you invest in a program that does not allow a change of account owners, I would recommend routinely signing the program's power of attorney when establishing the account to ensure that there is an agent designated with respect to the 529 account in the event the account owner becomes disabled.
For example, I found online a Fidelity Power of Attorney for Fidelity's 529 College Investing Plan. The Power of Attorney grants the agent (called the "Attorney-in-Fact" in the Fidelity form) the following powers:
If the program does not have its own preferred power of attorney form, the client might sign a standard general or durable power of attorney that is modified to specifically grant to the agent powers over any 529 account over which the principal is the account owner. Including specific authority in the power of attorney is advisable because under state law general grants of authority to manage assets often do not grant the power to make and revoke gifts, change beneficiary designations, or otherwise alter an estate plan, or take fiduciary actions. Authorizing a distribution from a section 529 account to the designated beneficiary could be construed as a gift for property law purposes (because until the distribution is made, the funds could be refunded to the account owner) and a fiduciary action. Refunding the section 529 account to the account owner could be construed as revoking a gift. Changing the beneficiary of a section 529 account could be construed as a fiduciary action or altering an estate plan.
I generally include specific powers over a 529 account in my standard powers of attorney because a client might open a 529 account without my assistance and may fail to sign the program's power of attorney, or the agent designated on the program's power of attorney may become unable or unwilling to act.
What's the difference between changing the account owner and granting an agent powers over the account through a power of attorney? First, a power of attorney is generally revocable, so the account owner could revoke the power of attorney and reassume the duties as account owner over the account. Second, if a nonqualified distribution were made from the account to the account owner, the account owner and not the agent would receive the funds.
Naming an agent under a power of attorney, however, is not a substitute for designating a successor account owner. A power of attorney is effective only while the principal (e.g., the account owner) is living. A power of attorney is revoked by the principal's death, so there is still a need to make certain that the appropriate document designating a successor account owner is in place. Most 529 programs have a form for designating a successor account owner.