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. Therefore, parents need address these plans in their property settlement agreement when getting divorced. This article highlights two specific areas regarding 529 plans in divorce - deductibility of losses and the use of plan assets to fund educational expenses.
Update: The Tax Cuts and Jobs Act suspended writing off losses from liquidated 529 plans, traditional IRAs and Roth IRAs for tax years 2018-2025. Please consult with a tax professional regarding your situation.
Prior to the new tax laws, the IRS allowed 529 plan owners to deduct their loss on their tax return if the plan was completely liquidated.
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. Note that Newburgh does not include a factor relating to college savings or other assets that may have been “set aside” by the parents. In fact, nowhere is there a statutory requirement indicating 529 plan assets should be exhausted first.
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.
More than ever, during this difficult economic time, advisors need to help divorcing couples take advantage of all the tax breaks available. If 529 plan assets are less than what was contributed, a complete liquidation should be considered.
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...