Section 529 Plans in Bankruptcy

16 Aug Section 529 Plans in Bankruptcy

Washington Univ. St. Louis

Washington Univ. St. Louis

If you file bankruptcy, you don’t want to risk your child’s education fund. Saving for college is hard. Congress made it easier with 529 qualified tuition programs which allow family to put money aside for children’s college expenses in a tax-favored way.

But what happens to that money if you file bankruptcy? The answer, as with most things, is “it depends.”

529 plans are odd to begin with. Nicknamed “529s” after the tax law provision creating them, federal law provides that contributions to the plan are a “completed gift” to the beneficiary. But the same law also gives the account creator control over the account — including the ability to cash the account out early, subject to a penalty, and the ability to change the beneficiary.

So the first question is whether the 529 account belongs to the beneficiary (e.g. the kid) or whether it belongs to the contributor (e.g. parent). The Eighth Circuit Bankruptcy Appellate Panel found that the 529 plans belong to the “settlor” or the person who set up the account and actually controlled it. That seems like the correct conclusion since since the settlor has complete control and right to dispose of the account.

So if the “settlor” files bankruptcy, that means they will lose the savings account? Not so fast.

Normally all property the debtor comes into the estate to be either liquidated for creditors or exempted for the debtor. Congress however decided to protect 529 plans a little. After the 2005 law changes, the 529 account might be entirely included in the estate, entirely excluded from the beginning or partly in and partly out.

Although the new law provision is written in a particularly obtuse way, the idea is that older contributions to a college savings account will be protected while newer ones will not. Or will not be automatically. Specifically, if the contribution was made more than two-years ago, it is not part of the debtor’s estate in the first place. For contributions made more than a year — but less than two years — ago, the first $5,000 contributed is kept out of the estate.

Finally any contributions made during the last year will be included in the estate. (The exclusions also depend on the beneficiary having specific familial relationships to the settlor and the contributions being within the allowed 529 limits.)

If part of the account does come into the estate, it can still be exempted to the extent the debtor has available exemptions. But Congress made a decision that saving for college is such an important goal that much or all of such accounts ought to be not only protected from creditors but kept completely out of a bankruptcy case.

The only serious exception is designed to deter folks from “stuffing” a 529 plan with money in the run-up to filing a bankruptcy. In balancing those goals, perhaps at least one section of BAPCPA was a good idea.

See In re Addison.

Photo courtesy: Bachrach44

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I have been a bankruptcy attorney since 1989. Our firm represents consumers filing bankruptcy almost exclusively, although I have represented bankruptcy trustees as well as creditors. For 2017-2019 I served on the American Bankruptcy Institute's Commission on Consumer Bankruptcy. Our Report recommended numerous changes to improve bankruptcy law to make it serve everyone in the process more effectively. If you live in Eastern Missouri, visit our website, send an e-mail or give us a call (314) 781-3400. Our website:
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