August 28, 2017

Out of State 529 Plans

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An increasingly popular, and rightly so, way to save for college has been use of a 529 Plan. These Plans allow for contributions to be made for a child’s education, and so long as they are used for that child’s education they grow tax free. If the child who is the beneficiary of the account does not go to college or does not need all of the money in the account for college, the 529 Plan Participant (the person setting up the plan) can designate someone else to receive the benefit of the Plan. In fact, the Plan Participant can change the targeted beneficiary of the Plan any time. 

529 Plans are administered by states. Different Plans in different states feature different investment vehicles, different investment performance, different fees, and many other features that may make a state other than your own a more desirable Plan for your purposes.

But there is one extra factor that an Indiana resident needs to consider in selecting which state’s 529 Plan in which to participate.

Indiana residents who select a 529 Plan sponsored by a state other than Indiana may have to pay Indiana inheritance tax on all of the funds in the account when the Plan Participant passes away. For example, if a grandparent establishes a Delaware 529 Plan for a grandchild, then the grandparent passes away before the money in the account is spent, the grandparent may well designate his/her child (the prospective student’s parent) as the successor Participant. This means that the son or daughter of the grandparent would be the one who decides for whom the funds in the 529 will ultimately be spent. On the grandparent’s death, the entire account balance will be included in the grandparent’s taxable estate for Indiana inheritance purposes and will be taxed as an inheritance by the son or daughter who becomes entitled to select the beneficiary of the Plan (not as an inheritance by the grandchild as one might expect).

If the grandparent had established an Indiana 529 instead of a Delaware 529, there would be no inheritance tax on the grandparent’s death with respect to that account. It is only other state’s 529 accounts that Indiana taxes. In most cases, Indiana inheritance tax rates are not high and exemptions will cover much if not all of the amount. However, if the 529 Plan is started when grandchildren or children are young or if large contributions have been made, there can be quite a lot of money in these Plans. In that case, (or even with a smaller 529 if other bequests to the successor Participant are substantial) inheritance tax can be an issue.

There may well be good reasons for using another state’s Plan, but for Indiana residents, inheritance taxation is one of the factors that must be taken into account when selecting a non-Indiana 529 Plan.