An Internal Revenue Code Section 529 (529 account) educational savings account can be an attractive investment vehicle, thanks to its tax benefits and flexibility. But a recent decision of the Court of Appeals of Iowa tells a cautionary tale about the limits of that flexibility if the 529 plan account is held in trust. (Alberhasky v. Alberhasky, No 18-0927, 2019 WL 2150810 (Ct. App. Iowa May 15, 2019)).
529 Accounts Established
As part of her estate plan, Alois “Allie” Alberhasky established a revocable trust. She designated herself as trustee, and her son, Rod, as a successor trustee. Allie enrolled the trust in four 529 accounts for the benefit of each of her grandchildren and deposited $65,000 in each account. When Allie died, Rod became a successor trustee of the trust and the successor owner of the 529 account designated for his son Max’s benefit.
Breach of Fiduciary Duties Claim
For many years, Rod had been embroiled in bitter divorce litigation with the mother of Max and Rod’s younger son, Grayson. Max chose to live primarily with his mother, while Grayson chose to live primarily with Rod. Max alleged that, after Allie died, Rod re-designated Max’s 529 account for Grayson’s benefit out of animus toward Max and, in doing so, breached his fiduciary duties. The district court dismissed Max’s claim, finding that, because the account was subject to a different statutory regime, the Iowa Trust Code didn’t apply, and Max lacked standing to challenge Rod’s administration of it.
Duties Apply to 529 Accounts Held in Trust
The appellate court reversed. The court acknowledged that, by statute, the owner of an Iowa 529 account may change the beneficiary designation at will and generally won’t owe fiduciary duties to the beneficiary. The court found, however, that the district court failed to consider that Max’s 529 account was enveloped within a trust. The court observed that the Trust Code didn’t expressly exclude 529 accounts and that the statute governing 529 accounts also didn’t place them beyond the reach of the Trust Code.
The court, therefore, held that the freedom of the owner of a trust-held 529 account to change its beneficiary designation remains subject to the fiduciary duties of a trustee as set forth in the Trust Code. Thus, Max stated a plausible claim by alleging that Allie created a trust for Max through her investment in a 529 account for his benefit and that Rod breached his fiduciary duties under the Iowa Trust Code by changing the beneficiary designation out of animus toward Max.
Immutability of Trustee’s Duties
Alberhasky serves as a reminder of the immutability of a trustee’s fiduciary duties, even when dealing with assets that may seem at first blush to fall beyond their scope. When a trust-held asset is subject to another legal regime that’s separate from trust law, Alberhasky teaches that the trustee nevertheless must manage that asset with the same loyalty and prudence that guide his administration of the trust as a whole. To do otherwise may expose a trustee to liability for breach of fiduciary duty.