A notable issue discussed in today’s news is the increasing costs of higher education in the United States. Congress has sought to help families pay for a child’s education by allowing them to pay into an entity frequently known as a Section 529 College Savings Plan. Parents can generally opt for one of two types of 529 Plans: a prepaid tuition plan that allows you to pay tuition at a particular university, or a tax-exempt savings account for a qualified beneficiary, generally a minor child or a grandchild.
Many parents and grandparents deposit large sums of monies into 529 Plans and understandably they are concerned whether a Chapter 7 Trustee will liquidate the child’s college education savings to pay creditors if they file for bankruptcy. Under Section 541(b)(6) of the Bankruptcy Code, assets in a 529 may or may not be protected from the reach of a Chapter 7 Trustee.
Whether a 529 Plan is Protected Is Based on the Timing of Deposited Funds
Protection of a 529 Plan can be divided in three categories:
- Funds deposited in a 529 plan over two years prior to a bankruptcy filing are fully protected from the Chapter 7 Trustee;
- Funds deposited one year or more, but less than two years prior to the bankruptcy filing are only partially protected. The first $6,425.00 contributed is excluded from the bankruptcy estate, while the remainder is not;
- Funds deposited less than one year prior to the bankruptcy filing will be included in the bankruptcy estate and receive no protection.
In essence, the older the contributions to a 529 Plan are, the more likely the deposited funds will be excluded from the bankruptcy estate. Furthermore, to qualify for protection, the account beneficiary must be the debtor’s child, stepchild, grandchild, or step-grandchild. You cannot take advantage of the bankruptcy protection afforded to a 529 Plan by establishing the account for yourself.
If a portion of the deposited funds is included in the bankruptcy estate, it may still be exempted to the extent the debtor still retains available exemptions, such as the wildcard exemption. Exemptions allow you to safeguard some assets from liquidation up to a certain dollar amount. The wildcard exemption allows you to protect any assets otherwise included in the bankruptcy estate. The federal wildcard exemption is currently $1,250.00 plus up to $11,850.00 of any unused portion of the federal homestead exemption. Therefore, for a single bankruptcy filer who does retain any home equity, the federal wildcard exemption is $13,100.00.
What if the 529 Pan is Not Exempt from the Bankruptcy Estate?
In the event a child’s 529 Plan is not exempt from the reach of a Chapter 7 Trustee, then the beneficiary may consider filing for Chapter 13. Chapter 13 bankruptcy does not require liquidation of a debtors’ assets, but a 529 Plan can still affect a debtor’s plan. This type of bankruptcy involves repaying creditors in a court-approved plan over three to five years. However, Chapter 13 creditors must receive at least as much payment as they would have if the debtor filed for Chapter 7 instead. For example, if $10,000.00 of a 529 Plan is non-exempt in a Chapter 7 proceeding, then the debtor must pay at least $10,000.00 to creditors to keep the account from being liquidated. Therefore, exempting a 529 Plan if it doesn’t fall under the protection of the two-year rule or other applicable exemptions means paying creditors an amount equal to the account’s non-exempt value.
Contact a New Jersey Bankruptcy Attorney for Help Today
If you have a 529 Plan for a child and are considering filing for bankruptcy, please speak with one of our experienced attorneys at Scura, Wigfield, Heyer, Stevens & Cammarota, LLP to discuss your options.