College is more expensive than it’s ever been, and experts believe those numbers will only continue to rise. Married parents often assume they’ll pay for tuition together when the time comes, but what happens when those same parents get divorced?
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 A 529 plan has many advantages – anyone can open an account; the money grows tax-free and is not taxed when withdrawn to pay for college; and many states give tax credits for deposits.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 fewer 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 the 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.
Parents should also consider who shall pay for college and to what extent. If the parties have only one college fund and multiple children, they should agree on 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. Colleges offer a variety of financial aid alternatives, and divorced parents should know how to best take advantage.
First, students with strong academic records – grades and standardized test scores – can qualify for merit-based scholarships at most colleges and universities. Some colleges will even give free tuition if the applicant has a certain grade point average and ACT score. As an example, at the University of Alabama, a student with at least a 3.5 GPA and a 32 composite on the ACT qualifies automatically for free tuition. Parents should look at a wide range of schools to see what merit packages might reduce the cost of college.
Second, students can qualify for financial aid, either through federal programs or institutional programs, or some combination of both. To determine eligibility, a parent must complete the Free Application for Federal Student Aid (FAFSA). For divorced parents, who completes the FAFSA becomes a critical issue.
FAFSA actually works in an odd way that favors lower-income divorced parents. If a married couple wants federal aid, both parents must complete the application and the combined household income must be reported. However, if parents are divorced, the custodial parent must complete the FAFSA and only that parent’s income will be considered for financial aid. If the custodial parent has a much lower income than the non-custodial parent, the child ends up the ultimate winner because the child will qualify for significant financial aid.
Divorced parents savvy enough to know how FAFSA works may try to game the system, but they need to be careful. In order to avoid committing fraud, the parent claiming custodial status must actually be able to demonstrate that – whether through the divorce decree or proof of living arrangements, or both. Divorced parents can agree to shift custody arrangements to help the child get financial aid, but the shift must be genuine.
Spousal support (what Missouri calls “maintenance”) also needs to be considered, and if the parent filling out the FAFSA has remarried, the income of the new spouse (the student’s stepparent) needs to be reported. This is the case even if there is a prenuptial arrangement that states that the stepparent will not be contributing towards the child’s college costs. As a result, remarriage could hinder getting financial aid. However, a divorced parent that cohabits with a new partner need not report that person’s income.
Parents should use all legal means to help position themselves for financial aid for college where those parents need that assistance.
Should you need the assistance of an experienced divorce and child custody attorney in Creve Coeur and O’Fallon or have questions about your divorce situation, know that we are here to help and ready to discuss those questions with you.