The Reality of 529 Plans in Divorce
In my practice, I have found while dividing assets that a 529 plan for the child is often put in the category of an asset for the children and not counted for either divorcing spouse. The reality is that a 529 plan is registered under one spouse’s social security number, with the child as a beneficiary. That specified spouse has ultimate control over the plan and can tap into those assets for personal use if necessary.
Let’s look at some details regarding 529 plans that legal professionals may not be aware of:
- Funds are contributed on an after tax basis, only the growth is taxed as ordinary income if the funds are not used for qualified higher educational expenses for the beneficiary child. Qualified higher education expenses are limited to tuition, fees, books, supplies, computers and related expenses and a limited amount of room and board.
- A non-qualified distribution (not for qualified higher education expenses) is taxed at the federal and state level and penalized 10%…but only on the growth. That penalty can be waived in certain circumstances, such as death or disability of the child or if the child receives a scholarship. In that case, the custodial spouse can withdraw the funds and use them for his or her own benefit without penalty. What if there is little or no growth? Then there is not much deterring the custodial parent from using those funds personally.
- If the beneficiary child receives a full scholarship, then the amount equal to that scholarship can be distributed without taxes and penalty. There is no guarantee that the parent will hand over those funds to the child.
- If the beneficiary child does not attend college, the funds can be rolled over to another family member, including: stepchildren, other children of the spouse, grandchildren, parents, stepparents, aunts, uncles, in-laws, first cousins and nieces and nephews.
Some clients have significant assets in the 529 account set up for the children. These accounts are often given to one spouse to manage without considering the possibility of that spouse mismanaging or misusing the funds. Education savings accounts should not be ignored and specific language can be added to the divorce agreement to prevent an ex-spouse from misuse of these funds