State Estate and Inheritance Tax Treatment of 529 Plans

Kathryn FlynnBy Kathryn FlynnBy Savingforcollege.com

If a 529 plan account owner dies before the beneficiary enters college, will the account be subject to state estate tax or state inheritance tax? In most cases, the answer is no. Each state has its own rules regarding taxes paid by heirs and estates. An inheritor of a 529 plan account may owe inheritance tax, depending on their relationship to the deceased and the account value.

An estate tax is based on the net worth of the decedent’s estate as of the date of death, and is paid by the estate. The estate tax is paid before anything is distributed to the heirs. An inheritance tax is based on the value of the bequest received by an heir, and is paid by the heir, unless the decedent’s will specifies that the estate will pay this tax.

529 plans and federal estate taxes

The federal estate tax is generally applied to property that is transferred to someone other than a spouse after the owner’s death. However, in 2020 only estates that are valued at $11.59 million or more are subject to the federal estate tax. Amounts that exceed the threshold may be subject to an estate tax rate of 18% to 40%.

There is no federal inheritance tax.

Contributions to a 529 plan are considered completed gifts for tax purposes, and the amount of the contribution is immediately removed from the donor’s taxable estate. 529 plan contributions up to the annual limit of $15,000 ($30,000 per couple) are not subject to federal gift taxes.

Gift givers also have the option to give a lump sum of up to $75,000 using superfunding, where the contribution is treated as if it were spread ratably over a five-year period. This allows grandparents to shelter a large amount from their federal taxable estate while helping to build an educational legacy for a grandchild.

There is an exception if the donor superfunds a 529 plan and dies before the end of the five-year period. For example, if a grandparent contributed the maximum $75,000 and dies during the third year, only the first $45,000 is considered a completed gift for tax purposes. The remaining $30,000 will be added back to the grandparent’s taxable estate, subject to federal and state estate taxes (if applicable).

Which states have an estate tax or an inheritance tax?


529 plans and state estate taxes

Thirteen states, including the District of Columbia, impose a state estate tax in addition to the federal estate tax. State estate tax exemption levels are significantly lower than the federal estate tax exemption, ranging from $1 million to over $5 million, which means estates that are not subject to federal estate tax may still owe state estate tax.

However, these states use the federal estate tax law definitions, inclusions and exclusions to determine the value of an estate. Since 529 plan contributions are treated as completed gifts and are not included in the donor’s gross estate for federal tax purposes, they are also not included in the donor’s gross estate for state estate tax purposes.

The states with a state estate tax include:

  • Connecticut
  • District of Columbia
  • Hawaii
  • Illinois
  • Maine
  • Maryland (has both an estate tax and an inheritance tax)
  • Massachusetts
  • Minnesota
  • New York
  • Oregon
  • Rhode Island
  • Vermont
  • Washington

529 plans and state inheritance taxes

State inheritance tax rates are based on the value of the property being transferred and who it is being transferred to. Inheritance tax generally does not apply if the assets are inherited by a lineal descendent, such as a child or grandchild. Spouses are exempt from inheritance tax.

For example, in New Jersey, if the inheritor is a spouse, child, grandchild, stepchild or mutually acknowledged child of the deceased they are not subject to inheritance tax. If the property is inherited by a sibling, son-in-law or daughter-in-law, the first $25,000 is exempt from inheritance tax.

The inheritor of 529 plan assets is typically the 529 plan successor owner. 529 plan account owners should consider their state’s inheritance tax rules when naming a successor owner.

States with an inheritance tax

Six states have an inheritance tax.

Are 529 Plans Exempt?

Exempt Beneficiaries

Tax Rates

Iowa

Yes

Surviving spouse, parent, grandparent, great grandparent, child, stepchildren, adopted child, grandchild, great-grandchild, most charitable, educational and religious organizations

5% to 15%

Kentucky

No

Surviving spouse, parent, child, grandchild, brother, sister, half-brother, half-sister

4% to 16%

Maryland

No

Surviving spouse, children or other lineal descendent, the spouse of a child or other lineal descendent, parent, grandparent, stepchild or stepparent, siblings or a corporation with only these people as stockholders

10%

Nebraska

Yes

Surviving spouse and most charities are fully exempt

1% to 18%

New Jersey

No

Surviving spouse, domestic partner, civil union partner, child, grandchild, great grandchild, parent, grandparent, great grandparent, stepchild, adopted child, mutually acknowledged child

11% to 16%

Pennsylvania

Yes, only Pennsylvania 529 plans are exempt

Surviving spouse, parents of children under 21 (including natural parents, stepparents and adoptive parents), working family farms, property owned jointly between a husband and wife

4.5% to 15%

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