My client brought me her settlement proposal to review and said, "He wants the kids' 529 plans, but he won't agree to pay for college. Now, I'm on the hook for paying for college if he won't, and we've been putting money into those accounts since the kids were born!" There's a lot here to consider, starting with some basic facts about 529 plans.
Similar to a 401(k) account, 529 plans are tax-advantaged savings accounts where money contributed is invested and grows on a tax-deferred basis. In some cases, you can also take a tax deduction for your contributions to a 529 plan (some states don't allow for this). You can take withdrawals from these accounts for certain IRS-approved expenses tax-free--for example, for education tuition and fee payments (including charter, religious and private school tuition from kindergarten through 12th grade), room and board expenses (if students attend at least half-time), books and supplies (and equipment--computers, etc.) and for equipment and services needed for special-needs students. These accounts are designated for the benefit of a specific individual, and the beneficiary can be changed to a different individual when needed. There are also pre-paid 529 plans that allow you to pay in advance for in-state tuition at today's rates.
Recent legislation changes have changed the practical applications of these savings plans for a divorce situation.
- Now that these plans can be used for tuition for kindergarten through 12th grade, using 529 funds may enable parents to keep their children in the same school post-divorce.
- Divorced parents can also use 529 funds to provide services and equipment for their special-needs child, which can provide immediate financial relief to both parties who may have post-divorce liquidity challenges.
- Unused 529 balances can now be transferred to a Roth IRA for the designated beneficiary (certain requirements and guidelines apply).
Changes to the FAFSA process dictate which divorced parent's tax information is used in calculating the Expected Family Contribution, and that amount is no longer prorated across multiple children. It's important to note that stepparents' incomes are also included in this calculation, even when they have no legal obligation to contribute to college expenses, and that 529 balances are included in the Expected Family Contribution calculation for financial aid eligibility. When my daughter was awarded a full scholarship to college, I asked my Ex to change her 529 plan to benefit our youngest son. This will give a longer timeframe for the funds to grow, and the funds will not apply to the Expected Family Contribution calculations for our two older children.
Since these accounts' approved uses are limited to approved expenses, any withdrawal for another purpose is subject to a 10% penalty. As you navigate your post-divorce financial situation, carefully consider whether or not this is the most effective place for your savings. I can help you assess the benefits of a 529 plan for your situation--schedule time to talk with me here.
Disclosure: A 529 plan is a tax-advantaged savings plan, issued and operated by a state or educational institution that helps families save for college. Investments in 529 plans are not insured by the FDIC or any other government agency and are not deposits or other obligations of any depository institution. Investments are not guaranteed and are subject to investment risks, including loss of the principal amount invested. Tax implications vary significantly from state to state. If you or the designated beneficiary is not a resident of the state offering a 529 plan, you may want to consider, before investing, whether your state or the designated beneficiary's home state offers its residents a plan with state tax advantages or other benefits. Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.