Most 529 plans do not allow joint ownership, and the funds are considered assets of the 529 plan account owner. That means in a divorce, the parent who is the account owner has the right to change the beneficiary or take a non-qualified distribution at any time.
Tayne recalls a client who assumed that an ex-spouse would take care of their child’s college savings, but the 529 plan account was never addressed in the divorce. When it was time to pay for the child’s college, there was no mention of the 529 plan and the funds were already gone.
To prevent a nightmare like this from happening, Tayne recommends including the child’s 529 plan in the divorce or separation agreement, clearly stating:
The 529 plan must be used only for the children of the marriage
The amount of college costs that will be paid for with the 529 plan
The amount of the remaining college costs that each party is responsible for paying
Before a divorce, it’s also a good idea to make the child’s custodial parent the 529 plan account owner. Distributions from a 529 plan that is owned by a non-custodial parent can negatively impact financial aid eligibility, similar to distributions from a grandparent-owned 529 plan.
Losing your college savings to a scary stock market
Some families saving for college fell victim to a scary stock market. For example, 529 plan investments took a big hit when the stock market dropped by as much as 40% in 2008. Families who panicked and pulled their money out of 529 plans essentially locked in their losses and missed out on the recovery.
A better strategy is to select appropriate investments when you open a 529 plan and reassess your level of risk at least once a year as your child gets closer to college. If you prefer a “set it and forget it” investment strategy, consider an age-based 529 plan portfolio that starts out invested in stocks and mutual funds and gradually shifts toward more conservative investments like bonds and CDs as the child gets closer to college.
Having your college savings account levied by a creditor
Tayne also reminds families that college savings accounts may be susceptible to creditors. She has had clients with 529 plan accounts that were frozen because of a debt that went to collections.
“It doesn’t matter that the point of the account was to save for your kid’s college, the creditor does not care,” she said.
However, in some states 529 plans are protected from creditors. Creditor protection rules for 529 plans vary by state. For example, in some states only assets held in an in-state 529 plan are exempt from creditor claims, and some states limit protection from creditors to a certain amount. The rules may also be different if the 529 plan was set up as a custodial 529 plan account.
Parents who are having debt issues should check their state’s rules regarding creditor protection for 529 plan assets. If your state does not exempt 529 plan accounts from creditor claims, Tayne recommends moving the funds into a different account. One option is to give the funds to a trusted friend or relative who can open a 529 plan account in their name and name your child as the beneficiary.