Divorcing couples often come into my office with the assumption that their child’s 529 college savings are assets of their children. Texas’ community property laws clearly state, however, that property acquired by either spouse during the marriage belongs to both spouses equally. And if a divorce occurs, the parties must divide that property “fairly and justly.”
Although assets can be gifted to others and, as a result, not be part of the community estate, a college 529 savings plan sits squarely subject to the same division as an investment portfolio or bank account.
Why does it matter that 529 funds are community property?
Thorny questions can emerge regarding college savings: what if my former partner gets married to someone who already has children or has another child and uses the money for the “new” family? How can I ensure this money saved will be used for its intended purpose—our children (the custodian of 529 funds may withdraw them at any time and use them for whatever purpose)? What are the tax implications? These questions must be resolved as part of a divorce, along with the division of other assets, all liabilities and parenting plan issues (529 plans are considered under the umbrella of “property.”)
What are my options if I don’t want my ex-spouse to have exclusive control over the 529 funds?
Several exist: establish a trust for the assets currently in the 529, divide 529 assets into two accounts within the same program, or put the assets currently in a 529 plan into a custodial account or a UTMA in both parent’s names (a “gift” account for the child once he or she reaches eighteen—but the child has the legal right to control and use these funds at age 18).
CAVEAT: To divide a 529 savings plan, assets must be withdrawn from the account and redistributed, essentially liquidating the plan.
Most college savings plans, like the Texas Tuition Promise Fund, for example, have tax penalties for non-education withdrawals, thus, in divorce, a percentage of savings is lost in the division. It is of paramount importance to determine the specific withdrawal penalties of your situation and to discuss the value of the saving with your attorney (and often, a tax professional). Is it worth it to divide this asset now for certainty moving forward if savings will likely be penalized from early withdrawal?
How can we avoid the tax penalty?
Generally speaking, the better option is to keep the fund under the name of one parent to avoid penalty. For the Texas Tuition Promise Fund, only one parent can be the “owner,” though both parents can continue to contribute even after a divorce.
The owner need not be the custodial parent, though it may make the process easier. In some situations, transferring ownership works best. This can be done by agreement, or a spouse can request that a judge transfer ownership in court as part of a divorce trial.
Why does it matter who “owns” the 529?
Often in divorce cases, ownership transfers to the custodial parent with the agreement from both parties to continue to contribute. Keep in mind, though, that regardless of who retains the plan, higher education costs are not part of child support in Texas, and must therefore be a clear and separate part of your agreement.
It is vital to state each provision clearly in the decree; do not assume that anything is “understood”; you’ll thank yourself later. In the shock of a divorce, many spouses cannot conceive of a time a 529 will be germane, they can’t even divide their sock drawer; however, rest assured, that time will come when high school graduation and college are upon you. Meticulous care now ensures 529 funds are allocated in the best way to advance your child’s future via college tuition.
Can the 529 be a point of negotiation?
For example, if you are the owner of the plan, you may choose to use the prepaid plan as an asset in negotiating for other property; giving up ownership in order to obtain full control of another asset you find valuable might be beneficial in the long run. Or in the case that one party makes much less money, an agreement can be made that the more “monied” spouse contributes an agreed-upon yearly sum to the 529 (while the less monied spouse is not required to contribute) and be solely used for their child’s college education in exchange for a transfer of ownership.
About the Author
Larry Hance is managing partner and founder of the Dallas law firm Hance Law Group. With more than 35 years of experience in family law, Mr. Hance uses his experience with the legal system, judges and other lawyers to help clients achieve the best possible results.