Choosing to file bankruptcy is never an easy decision to make, though concern for your children can make it even more difficult. Many parents put money aside to fund their children’s future college education—and if you are thinking about filing bankruptcy, you are probably very concerned about what will happen to that money. Can it actually be taken, or will it still be able to go toward your child’s college expenses in the future?
What Type of Account Is the Money In?
Many parents who have done their research use plans that are called ‘Section 529’ plans to save for their children’s college education. This is basically an educational savings plan that is operated by an educational or state institution. Almost every state has a 529 plan available.
Many parents who are contemplating bankruptcy panic when they realize that their 529 account and the money held within it are actually the property of the person who created the account—not the property of the child that it is intended for. So your 529 plan is actually your property.
There is, however, a safety net that still might protect your child’s future college money in the event of a bankruptcy.
Bankruptcy and a Section 529 Plan
The federal bankruptcy code actually excludes 529 plans and the money within them from the portion of your property considered for liquidation during the bankruptcy. Trustees and creditors, in this case, cannot collect money owed from this fund—which makes it safe in the event of a Chapter 13 or Chapter 7 bankruptcy.
Of course, in order for the money in the plan to be exempt, the child that you set the plan up for must actually be your child or grandchild. If you set it up for a nephew, for yourself, or for someone else unrelated to you, it is actually not exempt and can be accessible to your creditors.
While a 529 is technically safe from bankruptcy, that does not mean that you will not be penalized for recent transfers into the account. Any money transferred into it within the past year is not protected. Also, only $6,225 per beneficiary of money transferred into it between the span of one and two years prior is exempt from seizure.
Of course, these laws are intended to keep people from trying to use their Section 529 accounts to protect cash before filing bankruptcy—though they might factor into your decision and have at least some effect on your children’s future college savings.