Bankruptcy

College Savings Funds at Risk in Bankruptcy Filings

By Chris Kramer

A recent ruling by an Idaho bankruptcy judge, reported by the Des Moines Register, could mean bad news for parents with 529 tax-advantaged college savings plans for their children who file for bankruptcy.

The Ruling

The case in question apparently involved a couple who had put $14,500 into a 529 college savings account for their daughter. The girl?s grandmother reportedly contributed an additional $40,000. Ideally, the funds would have been used for the daughter?s education expenses (including textbooks, tuition, room, board and fees).

But, in this case, the girl?s parents filed for bankruptcy shortly after putting the money into the 529 account. And the judge overseeing their case ruled that the entire account (with the exception of the state?s $5,475 exemption) would be considered part of their assets and could thus be used to repay creditors.

The ruling landed this way, it seems, because the parents legally controlled the funds, and so could have used them for purposes other than their daughter?s education if they chose.

What It Means for You

So how could the Idaho bankruptcy court's ruling affect potential bankruptcy filers? If you or your relatives want to establish a 529 account for a child?s education, consider taking the following precautions:

• Invest early: Contributions made 720 days or more before a bankruptcy filing will likely be protected from the court. This provision was put in place to prevent filers from shielding their assets in 529 funds directly before a bankruptcy filing.
• Give up control: If you?re struggling financially but another family member interested in contributing education funds is not, consider keeping the account in that person?s name. That way, if you file for bankruptcy, the money will not be legally yours.

Further, the ruling in Idaho doesn?t necessarily mean that bankruptcy judges across the nation will follow suit in similar situations. While it?s likely that the same logic will be provided to other cases, it?s not guaranteed.

Besides, according to the Register, few people who file for personal bankruptcy have 529 accounts to worry about. But, if someone in your family is thinking about initiating such a fund, be sure to check with a lawyer first to make sure the money will be safe in case of a bankruptcy filing.

Additional Resources

A Guide to Understanding 529 Plans (PDF)

529 Tax Deduction Information (2009) (PDF)

Full post as published by The Bankruptcy Blog on December 19, 2009 (boomark / email).