Many couples establish savings for the college education of their children. A Section 529 account is an attractive vehicle for these savings, as discussed in Adam Swaim’s article. What happens to a 529 account if the parents divorce? The appeals courts of D.C., Maryland, and Virginia do not yet appear to have wrestled with a parental dispute about a 529 account in a divorce. Only a few cases from courts around the country have done so. They offer some guidance to parties and their lawyers as to how our courts may handle a dispute over a 529 account that arises between divorcing parents. More importantly, they point out issues that parties should address when negotiating a marital settlement agreement where they have a Section 529 account for a child.
Some key legal aspects of Section 529 accounts:
- The account-holder is the person who establishes the account (unless he or she has transferred ownership). The account-holder controls the disposition of funds from the account.
- The beneficiary is the person for whom the account was created. However, the beneficiary’s rights are not vested. First, the account-holder can switch beneficiaries, for example, to another child. Second, the account-holder can withdraw the funds for any purpose, although he or she will pay income taxes and a penalty if the funds are not used for qualified education expenses. By contrast, an account for a child established under the Uniform Gifts to Minors Act or the Uniform Transfers to Minors Act belongs to the child irrevocably. The custodian may only spend funds in the account for the benefit of the child.
- If the account-holder creates the 529 account with marital funds, for example, with wages or money from a joint bank account, the account will be marital property at divorce. This means a court could include the account in the pool of marital assets to be divided equitably between the parties at divorce.
- When a grandparent creates a 529 account and is the account-holder, the funds are not marital property. But, if the grandparent contributes to an account established and funded by the parent, that contribution is at risk of being treated as marital property because it has become commingled with marital property funds. A court may treat the entire account as marital property to be divided equitably.
Parties negotiating a marital settlement where there is a 529 account for a child should consider the following:
- If they intend to set aside the 529 account for their child’s education, the agreement should say expressly that the funds may only be used for that purpose;
- The agreement should address whether, if there are funds left over after a child completes undergraduate school, the funds will be made available to the child for graduate or professional school;
- The agreement could prohibit the account-holder from using the funds for any beneficiary other than the parties’ child, or other children of the parties, and not for a child of a subsequent marriage;
- The agreement should address the account-holder’s rights regarding leftover funds. For example, will the parent who is the account-holder be able to use the funds for him- or herself?
- The agreement should address the parents’ responsibility for the child’s education expenses that are not qualified education expenses, such as clothing, incidentals, transportation, living
expenses during summers and holidays, and the like; these cannot be paid with 529 funds;
- Some parties may want to agree to divide a child’s account and transfer partial ownership so that each parent is an account-holder. Even when they do, they should still consider the issues discussed above.
Parties who are unable to settle their case and will have a judge decide on division of their property should consider the following regarding 529 accounts for their children:
- Even if they are unable to agree on anything else, they could settle the question of the 529 account. Parents who funded a 529 with marital funds, and who are committed to see that their child have the opportunity for higher education, could stipulate to the treatment of the account. For example, they could stipulate that the account-holder will use the funds only for education of their children, and for no other purpose and no other beneficiary, and leave it to the judge to resolve the other issues in the case.
- A party who wants a 529 account to be treated as nonmarital property, for example, an account funded entirely with grandparent gifts or entirely with the parent’s nonmarital property, or some of each, must be prepared to prove with documents the source of the gifts into the account.
- He or she must also provide documents that show the court that the account in question is a Section 529 account, and not something else, such as a savings account that a party has merely earmarked for a child.
Unfortunately, several reported cases from around the country that resolve a parental dispute over a 529 account have held these accounts are divisible marital property. Courts in Indiana and South Dakota have ruled that accounts established with marital funds are marital property. Courts in other states have strained to find a way to keep a 529 intact for the child. For example, an Alaska judge ruled that the very act of creating a 529 account for a child was an implicit spousal agreement to use the funds as intended. Whether a court in Maryland or D.C. would adopt that argument is an open question. In Virginia, spousal agreements are governed by the Virginia Marital Agreement Act, which mandates that all such agreements be in writing and signed. A purported oral agreement regarding disposition of a 529 account will not suffice in Virginia.
Despite these potential problems, Section 529 accounts remain an appealing vehicle for college savings. It also seems that most divorcing parents who have a 529 account agree to use it as intended. Perhaps that is the reason there are so few cases about them from courts of appeal arising out of divorce.