There is no Generation-Skipping Transfer (GST) tax on 529 distributions.
The GST tax is unusually a concern for the contributions to a 529 plan.
Qualified distributions from the plan are state and federal tax free.Non-qualified distribution earnings are penalized 10% and taxed at the owner’s federal and state levels.
Note that if there is to be a known non-qualified distribution, ownership transfer to the lowest income person–usually the student–should yield the lowest tax rate.
Larry’s grandmother saved through her life, then just before her death last year superfunded his account with $490,000. She then transferred ownership to his father. Larry is nearly finished paying for school and wants $100,000 of this money for a house down payment. Because his grandma recently funded the account, it has only grown $10,000 to now total $500,000. Larry’s father–who is in the 32% tax bracket–now transfers the account ownership to Larry. Larry is only in the 12% federal tax bracket and will owe 2% state tax. Larry withdraws a non-qualified $100,000 (⅕ of the money), and pays 10% penalty on $2,000 (⅕ of the earnings). With $200 penalty plus $240 federal plus $40 state taxes, Larry keeps $99,520.
No statement or example on this site should be considered a specific recommendation for your personal situation. Investing and tax strategies each carry significant risks. Examples herein may not apply to your situation. Please consult your estate attorney, tax advisor, or financial advisor for personal advice.