As the cost of college continues to increase, many parents opt to open 529 plans in order to help save for their children’s tuition. These plans, which are operated by a state or educational institution, offer federal and state tax benefits and allow the donor—often a parent—to retain control of the account.
When it’s the parent, not the child, who has control of the funds, the 529 plan is considered a marital asset. This is important to remember in the event of a divorce, when parents will need to specify how the 529 plan will be funded and used. (A 529 plan can only have one owner, even when parents are married.)
The basics of a 529 plan
Unlike traditional and Roth IRAs, which both have an annual contribution limit of $5,500, substantial amounts of money may be deposited into a 529 plan every year—up to five times the annual gift tax exclusion rate. In 2014, that means you can deposit $70,000 (a gift of $14,000 a year or less qualifies for the gift tax exclusion in 2014) without needing to file a gift tax return, provided you elect to spread the gift evenly over five years.
Anyone can contribute to a 529 plan, including either parent, other family members, friends, and even the child him or herself. However, there is a total contribution limit that varies by state. Generally, that limit is $300,000 and up, but the limit may be raised each year to keep up with rising college costs. Once this limit is reached, no more money can be added to the plan.
The 529 plan taken into consideration when a dependent applies for financial aid, whether it is held in the name of the parent or the student.
What happens to a 529 plan if you get divorced?
In the event of a divorce, a 529 plan, which is a marital asset, needs to be considered when you and your partner discuss separating your finances. For example, you may want to split the 529 plan into two separate accounts so you each have control over a share of your child’s college savings. Or, if you are uncomfortable with your partner owning the account, you may want to switch ownership of the account from your partner to you. You may also want to leave the asset in your partner’s name, cease contributions, and open your own 529 plan for your child.
In any case, you may want to include in your divorce decree the specifics of how the 529 plan funds should be used. Regardless of who owns the account, the money in it should remain set aside for the child.
Things can get more complicated if your partner owns the account and wants to withdraw the funds for non-educational use. There are tax implications—whoever withdraws the money for non-qualified use will pay income taxes and a 10 percent tax penalty on the taxable amount of the withdrawal—but it’s the child who really loses because those college funds are gone. If it’s not outlined in the divorce decree how the funds are to be used, you may have no control over your ex withdrawing them.
If your partner retains ownership of the account, consider having yourself designated as the successor owner in the event that he or she dies. If no successor owner is named, the new account owner may have to be decided through probate.
You should also think about what will happen if your child doesn’t want to go to college or trade school. Who will get the money in the account? If the designated beneficiary chooses not to pursue higher education, whoever controls the 529 plan will have the power to confer these funds to someone else by changing the designated beneficiary. This means that if your child doesn’t want to go to college, but a sibling or relative does, the account owner could make that person the beneficiary of the account. The account can even be used to pay for the account owner’s own education.
Overall, 529 plans may be a good way to help provide your child with a future because you can contribute a substantial amount of money each year. But be sure your divorce decree clearly states how the funds should be used.
Eva Rosenberg, EA is the publisher of TaxMama.com ®, where your tax questions are answered. She is the author of several books and ebooks, including Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and tax courses you might enjoy at http://www.cpelink.com/teamtaxmama.