One often overlooked aspect of financial issues during divorce involves college funding for the children. Many couples take advantage of Section 529 of the Internal Revenue Code and open a savings account for their children to begin saving for college. A 529 plan has many advantages – anyone can open an account; the money grows tax free and is not taxed when withdrawn to pay for college; and many states give tax credits for deposits. What should couples do with the 529 plan when they divorce?
While a 529 plan can be subdivided like a retirement plan, choosing to do so generally lessens the overall value of the plan. First, a plan earns more interest if compounded in a single account rather than split up into separate accounts. Second, a 529 plan counts as an asset when applying for financial aid for college loans. Third, having two people with separate accounts with separate control really makes little sense when the only use of the fund can be for paying for college.
A 529 plan can have only one individual who exercises the power of withdrawal. Both spouses can make contributions and both spouses can have access to the activity in the account, but only one can be the designated owner of the account. So, who should have that ownership? Generally, the noncustodial parent. For parents who need to apply for financial aid for college, the parent with custody of the children completes the FAFSA, the application form. The less assets and income the parent has, the more eligible that parent becomes for federal aid. Because the 529 counts as an asset, it will hurt the chances of qualifying for aid if the custodial parent has those funds.
With the noncustodial parent as the owner, the custodial parent should be listed as a designated user so that parent can see what happens in the account. Also, the custodial parent should be listed as the successor owner in the event of the death of the noncustodial parent.
During the divorce negotiations, parents should consider who will continue to make contributions and in what amount. Obviously, if the contributions stop coming into the account, the value of the account will not grow nearly as much. To assure that one or both spouses continue the contributions, the parties should consider making that an obligation in the separation agreement.
Finally, parents should consider who shall pay for college and to what extent. If the parties have only one college fund and multiple children, they should agree what percentage shall be available to each child. Also, the agreement should state that all payments to college exhaust the available funds to each child before a parent has any obligation to pay. After exhaustion, the parents should agree on a percentage share contribution and a cap on an annual amount. Having these financial aspects set out clearly in an agreement makes it easier for parent and child to plan on what colleges would be affordable and to what extent a parent or child might have to seek financial aid, as well as assuring that one or both parents do not end up on the hook for a college sum neither can afford.
If you have questions about funding college after divorce, contact us – we can help.