The Intersection of 529 Plans and Trust Law… Do They Collide or Work in Tandem?
In the recent Iowa case of Alberhasky v. Alberhasky, a trustee changed the beneficiary of a 529 Plan which was created with funds from a trust. The primary issue was whether the trustee violated his fiduciary duty for changing the beneficiaries of the 529 from 2 sons to one son.
For those unfamiliar with 529 Plans, these plans are authorized under Section 529 of the Internal Revenue Code (the “Code”) and are qualified tuition programs. Contributed funds can be used for educational expenses for the beneficiary. These educational expenses are broader than prepaid plans and include tuition, fees, books, supplies, and equipment needed for enrollment.
Funds contributed to a 529 Plan are treated as a present interest gift even though it may not benefit a child or grandchild until the future. Funds in the 529 Plan are not included in the donor’s estate for federal estate tax purposes. Further, the donor can “front load” or make a gift in one year for 5 times the annual exclusion (currently 5 times 15,000). Income tax is not due on the increase in the value of the funds. However, if the funds are improperly withdrawn before use for qualifying educational expenses, then penalties and income taxes will apply. Many states, including Florida have their own 529 Plans.
Against this backdrop, in Alberhasky, grandmother, Allie, created an Iowa trust for children and grandchildren (the “Trust”) in 2000. Allie’s son, Rod, had 2 children, Max and Grayson.
Rod and his wife divorced in 1999 prior to the date of the creation of the Trust. Apparently, as the court noted in a footnote, “Max chose to live primarily with his mother, while Grayson chose to live with Rod.”
In 2010, the Trust funded a 529 Plan in Iowa with Max as the named beneficiary. The Trust also created 529 Plans for 3 other grandchildren.
Allie died in 2011 with Rod and Rod’s sister, JoEllen taking over as co-Trustees.
In 2012, Rod modified the 529 Plan removing Max as the beneficiary and replacing him with Rod’s other son, Grayson. It is unclear from the facts whether Rod acted alone as trustee or if he and JoEllen acted as co-trustees.
Max brought a lawsuit against Rod for changing the beneficiary of the 529 Plan. Max argued that the change of beneficiary from Max to Grayson was a breach of Rod’s fiduciary duty as a co-trustee. Generally, a donor of funds to a 529 Plan can change the beneficiary to another beneficiary, provided the beneficiary is a member of the family as defined in the Code. Iowa’s 529 Plan permitted such a change. However, Max argued that because the 529 Plan is a trust asset, Rod is governed by fiduciary duties imposed under the Iowa trust code.
Rod moved the court to dismiss Max’s action as he had no standing and the Iowa trust code had no application to these facts as this was a 529 Plan under Iowa law and the 529 Plan was not subject to the Iowa trust code.
The lower court found for Rod and Max appealed the decision to the Iowa Court of Appeals. The appellate court determined that the lower court did not properly analyze the Iowa trust code to determine its applicability to the 529 Plan created with trust assets. The court cited Susan T. Bart’s ACTEC Journal article…”If a trust is the account owner, the trustee is bound by the terms of the trust and has a fiduciary duty to the trust beneficiaries.” The court determined that Max’s motion should not have been dismissed and remanded the case for further proceedings to apply the Iowa trust code and determine whether the fiduciary duty had been breached.
ADVICE: This author has not seen a donor/trustee create a 529 plan through a trust. Normally, the 529 Plan is created with funds from a parent or grandparent directly for education for their children or grandchildren. The donor takes advantage of the 5 year front loading gift tax exclusions and the estate tax exclusion. If a trustee is considering creating a 529 Plan, then any change may be a breach of fiduciary duty by favoring one beneficiary over another. Query, if a beneficiary of a 529 plan created in a trust agrees to have another named, is that a gift from the original named beneficiary? If you do want to provide that a trustee can create a 529 plan, then put such power in the trust document.
WORD OF THE WEEK: Educational expenses included in a 529 plan are very broad. They include college tuition and fees, vocational and trade school tuition and fees, elementary and secondary school tuition, off campus housing, books and supplies, computers, computer software, internet services, special needs equipment and business equipment if used in college courses. Of course each 529 Plan must be reviewed and confirmed for the qualifications and the necessary requirements.
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