Parents who started 529 plans, tax-advantaged education savings plans, without naming a successor are at risk of having someone they don't know control their child's education funding if they pass away, says Lynne Ward, executive director of the Utah Educational Savings Plan.
A successor is a person that retains control of the account if the account owner - normally one of the parents - passes away or becomes no longer capable of making decisions, she says.
Parents who name a successor still risk that person not following their wishes. While adults in the U.S. can expect, on average, to live past 75, according to data from the Centers for Disease Control and Prevention, it's important for parents to prepare just in case.
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First, understand the procedure for naming a successor. Parents should ask 529 plans for a form to name both primary and secondary successors, Ward says. The account holder submits the form naming a successor as the new account owner, and if the owner dies the primary successor then assumes all control of the account.
The successor has all the rights of a traditional account owner, Ward says. He or she makes decisions on how the money is invested and how it can be used by the beneficiary who will ultimately use the funds for an education. The successor can also choose to change the beneficiary, she says.
As a result, parents should think carefully about whom they trust enough to control that account. Most of the time people name family members, such as a child's aunt or uncle, as successors in the hope they'll keep the child's best interests at heart.
"An account owner should select a successor they have confidence in to fulfill their goal for the 529 plan accounts," says Ward. "A successor may be a spouse of the account owner, a parent of the beneficiary if the account owner is a grandparent" or a trust that carries out the original account owner's wishes.
Grandparents who opened accounts don't have to make the parent or another relative the successor, just as any account holder doesn't. Arkansas College Savings Plans Project Coordinator Dale Ellis recalls a conversation he had with a grandfather about naming a successor on a 529 plan he owned. He didn't want the parent to gain control of the plan.
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Ellis says he replied that "If you have a specific desire for the money to be used in a certain way, make sure you choose someone of like mind that will use the money for the education of the child - no matter whether it's a parent or another person."
If no successor is named on an account and the account owner dies, the beneficiary becomes the account owner, Ward says. If the beneficiary is younger than age 18, it's possible the state will assign someone to make decisions on behalf of the child until the child becomes a legal adult.
The state could also do this if the primary successor dies and a secondary successor isn't named. States may have different rules on exactly who is named, experts say.
"The plan may name the beneficiary to be the owner if over 18," Eisenberg says. "However, what happens if the 19-year-old beneficiary decides to buy a Corvette instead of an education? Remember, the owner of the plan has full power to use the money for any purpose whatsoever." Not using funds for education can result in tax penalties for the new account owner.
But the procedure may be different on a state-by-state basis, says Los Angeles-based attorney and financial specialist Michael Eisenberg. "If you don't name a secondary owner or if you don't have adequate estate planning documents, your estate could go through probate and that could tie up the funds for a very long time."
To ensure college savings are used the way they would like, parents can have 529 plan withdrawals distributed by the executor of their will. The executor can then apply specific rules for the money being used for education.
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However, it's not guaranteed the rules families spell out will be followed
"You could request that the executor of your estate use the funds for the college education that you initially desired but just be aware that there could be beneficiaries who contest the will. Remember that sometimes beneficiaries plus money equals litigation," Eisenberg says.
In summary, name primary and secondary successors who will follow your wishes, Eisenberg says. But also prepare for possible taxes if the successor takes over.
"Check your state 529 plan rules to make sure that there are no state restrictions on ownership transferability," Eisenberg says. "You don't want to be surprised that upon the original owner's death, the transfer to a new owner would be subject to tax."
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