Will My Child’s College Savings Be Affected if I File Bankruptcy?

Are 529 College Savings Exempt in Chapter 7 BankruptcyLike so many answers to legal questions, the answer here really is: “it depends.” Whether the savings you have put away for your child’s college education will be available to a bankruptcy trustee depends on what chapter of bankruptcy you file, in what type of account those savings are held, and finally, how long ago you contributed to these college savings. Our Bay Area bankruptcy attorneys have successfully handled hundreds of cases and many in which the bankruptcy debtor held college savings for the benefit of a child.

First of all, assets of a debtor are only available to be taken by the trustee in Chapter 7 cases, not in Chapter 13. Secondly, in Chapter 7, the college savings may be entirely or partially excluded from the Chapter 7 bankruptcy estate, and hence beyond the trustee’s authority to seize the asset depending on whether the college savings are held in the right type of account. Funds held in accounts qualifying as a 529 College savings plan, may be safe in a Chapter 7 Bankruptcy, but there are some fairly arcane rules governing the extent to which such savings will be excluded from the bankruptcy estate or will have to be exempted under an available exemption. First of all, to be excluded, the 529 Plan must have been established and funded more than one year prior to the debtor’s bankruptcy filing. Funds held in such a plan are entirely excluded from the bankruptcy estate under 11 USC Sec. 541(b)(6) as long as the funds were contributed more than 720 days (2 years) prior to the bankruptcy filing.  That’s right, provided they do not exceed the limits set by the state 529 plan (provided for in IRC Sec. 529(b)(6)) contributions made by the debtor to a 529 Plan made more than two years prior to the filing of the Chapter 7 case, including all growth on those contributions will be entirely excluded from the Chapter 7 bankruptcy estate, and thus will be totally safe from being taken by the Chapter 7 bankruptcy trustee. Contributions made more than one year but less than two years prior to the Chapter 7 filing are exempt only up to $5,000. Contributions made within one year of the Chapter 7 filing are not, unfortunately, excluded from the bankruptcy trustee, but they may be exempted to the extent there is an available exemption such as California’s wild card exemption.

What about contributions made to a child’s 529 plan not by the debtor, but by other family members or friends? This is a murky area given that the debtor is with most 529 savings plans the owner of the account with full control over the account. However, some financial institutions do offer different types of 529 plans. For example, some offer a 529 plan that has all the features of a Uniform Transfers to Minors Act (UTMA) account but still qualify as a 529 savings plan. These do have some drawbacks, however. For example, the ultimate beneficiary of the account cannot be changed as with regular 529 accounts, and once the child turns 18, the entirety of the account becomes the property of the child. She will be free to use the money in non-qualifying ways, and thus lose the tax advantages of a 529 plan. However, provided that she does use the funds for qualifying educational expenses, then an UTMA 529 plan will enjoy identical tax free growth and withdrawal as a regular 529 plan.

From a bankruptcy and asset protection perspective, having a separate UTMA 529 plan set up for your child could offer a safer place for relatives and friends of the child to make contributions. Presumably, because the contributions did not come from the debtor and because the debtor has less control over the UTMA account, the bankruptcy trustee should not be able to reach even recent contributions provided they did not come from the debtor. I am aware of no case directly dealing with an UTMA 529 account in a Chapter 7 bankruptcy, however, so this remains a speculative point, though I think the argument is solid. Most importantly, one should begin making contributions to any type of 529 college savings plan as early as possible. Whatever one’s risk of liability in life be, should the worst case scenario necessitate filing for Chapter 7 bankruptcy protection, then savings in a 529 contributed more than two years prior to the filing will be completely protected from one’s creditors and the bankruptcy trustee.

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