In many divorces, parents spend a lot of their time negotiating the terms of equitable distribution of their assets and spousal support. Because child support terms are largely dictated by state law, there’s not as much deliberation in that area. And caught in the middle are things like 529 plans, which are assumed to be the ‘child’s’ asset, but are in fact usually the asset of one of the parents. Not accounting for this in a divorce might lead to unfortunate consequences down the road, even for the most well-intentioned families.
So to answer the question up front:
What happens to your child’s 529 plan in a divorce largely depends on whether you actually address it as part of the divorce process.
This article outlines some of the divorce-specific details of 529 plan ownership, possible pitfalls and opportunities, and considerations for both parents to ensure the proper stewardship of their children’s 529 plans.
By nature, most 529 plans (also known as college savings plans) are established by parents as a means to set aside money to pay for a college education in a tax-advantaged manner. While contributions are made with after-tax dollars (for federal purposes), earnings in a 529 account accrue on a tax-deferred basis, and qualified distributions are not taxed. For residents who pay state income tax, there are often state tax advantages for contributions to their home state’s 529 plan.
When they set up the 529 account, many parents usually don’t pay attention to the ownership of that account. While some states allow for joint ownership between married parents, some plans, like the Nevada Wealthfront 529 College Savings Plan, do not. And even in cases where the plan allows for joint ownership, many applications are filled out by one (usually weary, sleep-deprived) parent. So it’s easy to fill in one parent’s name on the application and move on, assuming that the child actually owns the assets in that account. And for parents who don’t get divorced, that’s usually not a problem. For divorcing parents, it could be a huge problem.
Possible Pitfalls and Opportunities
The biggest problem that can occur is that after the divorce, the account owner (in a non-joint ownership account) can do literally whatever they want. For the other parent, this can be a very big problem, particularly if there are nasty circumstances involved. Here are a couple of examples:
Account owner pays for a private high school education, while the other parent wants to keep money available for college (or vice versa).
Account owner changes beneficiaries, against the non-account owner’s wishes. They can even change the beneficiary to a new step-child.
Account owner withdraws funds for non-college purposes. This is completely legal, as long as the owner pays the associated taxes and penalties.
One parent is court-ordered to fund a 529 plan for college education, but the other parent has no obligations to spend the money on college.
While these possibilities might be identified by a proactive divorce attorney, or a discerning family court judge, there are many cases where 529 plans fall through the cracks.
On the flip side, there are several financial planning opportunities available to divorced couples who share a common vision for funding their children’s college education, particularly when it comes to applying for financial aid. While detailed information is beyond the scope of this article, these opportunities primarily revolve around strategies that optimize the owner and distribution of 529 plan assets in a manner that minimizes impact on financial aid eligibility. In other words:
If financial aid is an important part of funding your children’s college education, who owns the account, and how the disbursements are handled can have a huge impact on eligibility.
While these opportunities abound when it comes to financial aid, they can only work if both parents agree to terms that set the conditions to take advantage of them. And financial aid is only part of the entire college planning picture. Which in turn is only part of the entire financial planning picture.
And since a divorce often occurs ten years (or longer) before a child even is ready for college, it’s important to allow for college planning in the divorce decree. While you can’t nail down every possible contingency or regulatory change in advance, there are things you can do to set your children up for success. And one of those things is to ensure that your children’s 529 plans are properly addressed in your divorce agreement.
529 Plan Considerations For Your Divorce Agreement
While each divorce has unique circumstances, there are a couple of things you should do:
Hire a financial planner who specializes in divorce. In addition to the traditional divorce planning services, a financial planner’s true value is in keeping their eyes on your money—where it is, what could happen to it, and how to protect against bad outcomes. While your attorney is focused on your best interest, their advice usually is limited to legal, not financial advice. A financial planner can help you through the divorce, and often can help you with college planning afterwards as part of an ongoing service.
Talk with your attorney about your 529 plans to make sure they’re addressed as part of the divorce settlement. Depending on the state you’re in, and how collaborative (or combative) your divorce might be, your lawyer might have different suggestions on how this gets done. Your focus should be on ensuring that the divorce paperwork addresses them properly, specifically ensuring that:
Both parents have equal say in the distribution of assets, even if one of them retains ownership of the account.
The 529 plan(s) are properly accounted for as part of the equitable distribution.
Future college contributions are taken into consideration as part of the settlement. This includes ensuring that contributions made by one parent are safeguarded against improper use by another.
Clearly defining which education uses are eligible, and which are not. This is of particular importance if both parents disagree on whether 529 funds should be used to fund K-12 education.
If your children are old enough, talk with them about their 529 accounts. Many parents believe their children aren’t old enough to have a conversation about your plans to fund their college education. However, children of divorcing parents are going through a tumultuous time. It’s important to have the conversation to let them know that both parents still care for them. And that includes talking to them about money that their parents are saving for the future. A kindergartener can understand the basic concepts, even if they might not understand all the details.
Divorce is a financially stressful process, particularly because it’s so impactful on other areas, like college planning. But it’s important for divorcing couples to take the time to understand where all of their money is, and to safeguard against bad outcomes. Even the most well-intentioned families can stray off course over time, particularly if the divorce paperwork doesn’t specifically address what can or cannot be done with a 529 plan.
And if you’re ready to take the next step and work with a financial planner, you can learn more about how we work with clients right here.