Addressing College 529 Plans in Divorce

College 529 plans are tax-deferred college savings plan and a relatively new way to save for college education expenses. They be used to fund a child's education at a traditional college or other eligible post-secondary educational institution. With the Tax Cuts and Jobs Act, 529 plans can now also be used to pay for private elementary and high school tuition. 

Even though many people view a 529 plan as the child's asset, it is actually a marital asset. Account ownership is generally in one parent's name and the child is named as the beneficiary of the plan. Therefore, parents need to address these plans in their property settlement agreement when getting divorced. This article highlights a specific area regarding 529 plans - the division of plan assets to fund educational expenses when the parents divorce.

College 529 Plans and Divorce

by Noah Rosenfarb

Use of 529 Plan Assets

A 529 savings plan is considered an asset of the account owner (generally the parent), even though it's meant to pay for the child's college expenses. 529 plan assets are utilized to fund education expenses until they are exhausted. After, parents make contributions in accordance with the statutory factors at the time of the event or based on percentages agreed upon during divorce. If you allow one party to retain control of 100% of 529 plan assets, I recommend you include restrictions on liquidations and changes in beneficiary.

However, I suggest an alternate scenario should become commonplace, as it may achieve greater equity. 529 plan assets should be distributed, generally 50/50, to the parents. Each parent would utilize their share of 529 plan assets as they deem appropriate, unless their agreement dictates certain restrictions. Without restriction, some parents may choose to completely liquidate the plan and realize losses. Perhaps some would change the beneficiary designation.

Then, at the time the child enters college, each parent would contribute in accordance with whatever case law applies at that time. To avoid a tax penalty, the funds can only be used for qualified expenses such as tuition, books, and room and board. But, nowhere is there a statutory requirement indicating 529 plan assets should be exhausted first before other college saving assets are used to fund a child's education.

Let’s use an example: As a result of restrictions in their agreement, both parents kept their 529 plan assets untouched since their divorce and now have equal sums of $25,000. Dad’s income is $150,000 and he has $250,000 of other assets. Mom has $50,000 of income and $150,000 of other assets.

How should they contribute to college? Do you think the first $50,000 of education expenses should be paid via $25,000 of 529 plan assets each? If not, then you should consider this alternate settlement scenario to achieve an equitable outcome with respect to college expenses.

Updated 529 Plan Tax Laws

Update: Prior to 2018, the IRS allowed 529 plan owners to deduct losses on their tax return if the plan was completely liquidated and the account value was less than the contributions. The Tax Cuts and Jobs Act suspended writing off losses from liquidated 529 plans for tax years 2018-2025. And the 2025 Tax Reform Bill made this provision permanent. In simple terms, you can't deduct your losses.

The 2025 Tax Reform Bill also raises the yearly limit for 529 account distributions for K-12 education expenses from $10,000 to $20,000. This change will apply to tax years starting after December 31, 2025. Please consult with a tax professional regarding your situation.

Conclusion

More than ever, during this difficult economic time, advisors need to help divorcing couples make smart financial choices. Further, as a family law community, we need to re-think the equitable distribution of 529 plan assets. Often, they should be split equally by the parties and college expenses should be paid by parents at the time of the event in accordance with the then effective statutes.


For more information on how other investments are handled in a divorce, continue reading... 

Resources:
Divorce Strategies Group: Dividing 529 Plans in Divorce