Divorce is so complicated that the decisions regarding college planning are often left unaddressed causing disagreements when they do have to be made. Most divorce agreements have a plan as to how to divide other assets that have been accumulated during the marriage, the family home, cars, collectibles, joint bank accounts, retirement and brokerage accounts but when it comes to other savings, such as college savings or 529 plans, often the agreements are too vague. Couples operate from assumptions, such as the parent who established the account controls it, and absent any other agreement that will be true. But we all have suffered the consequences of operating under the wrong assumptions, and for divorcing families, when they make assumptions, the mistakes they make often mean they pay more for college education than is necessary.
For example, during divorce most accounts are divided but that does not have to be the case for college savings or 529 plans. In fact the division of these accounts may either overcomplicate things or serve failing purposes. There is much more to consider in dealing with educational funding accounts than a simple division of assets.
First, it is generally assumed that 529 plan funds continue to benefit their children and that these funds will pay for a college education. Most agreements that address these accounts allow each parent to continue to contribute to them and by agreement how the funds can be used. Under the new tax legislation, however, funds can be used beyond college costs, such as for private high schools, and agreements should probably address these new possibilities and the process of agreement upon expenditures. What if a child chooses not to attend college but another form of advanced education, revisiting this agreement in this instance should be addressed. If there are insufficient college savings but there are other savings that could be used for college, agreements should address which savings should be allocated first. If agreements require ongoing contributions to 529 plans they should spell out when they terminate and may even stipulate the maximum age at which the children can use the money in the account for educational purposes. Agreements should also clearly state how assets remaining in the account after that date are to be distributed, if they have not been used for college and who should pay the tax penalty. This obviously requires that each party be able to see the statements, so agreements should address how and how often. A simple solution is to name the parent not managing the account as an interested party with the custodian.
For some families who struggle in their ongoing relationship it may be clear these accounts should divided and they generally can be without penalty. An obvious situation is where parents do not have good working relationships. Separating accounts serve to avoid ongoing conflicts and each parent can then decide their own deposits to be made to the account and how their funds might be used.
Divorce Decisions Affect College Aid Eligibility
In addition decisions regarding 529 plans can have a great impact on eligibility for financial aid mostly by which parent owns the 529 plan and who and when they take the distributions.
When parents are divorced, completing the Free Application for Federal Student Aid (FAFSA) is the responsibility of the custodial parent (the parent with whom the dependent student lived the most during the 12 months ending on the FAFSA filing date). If the student lived equally with both parents, which can happen in a recent divorce, the custodial parent is the parent who provided more support. If the custodial parent owns a 529 account, it’s reported as an asset on the FAFSA but distributions are ignored. Need-based financial aid eligibility is reduced by a maximum 5.64 percent of the asset value. If the non-custodial parent owns a 529 account, it isn’t reported as an asset on the FAFSA but distributions count as untaxed income to the student. This reduces need-based aid eligibility by as much as half of the distribution amount. Thus the timing of the distributions is critical and possibly should be left to the final few years when the FASFA look back would have less of an impact
Assume the 529 account has a $25,000 balance and it’s spent to zero during freshman year. If the custodial parent owns the account, the worst-case scenario is it reduces aid eligibility by $1,410 (5.64 percent of $25,000). If the non-custodial parent owns the account, the worst case is it reduces aid eligibility by $12,500 (half of $25,000).
These considerations may also give guidance as to annual custodial arrangements, division of 529 plans and whether and how they should occur as well as distributions and their timing
Stepparents are also a consideration. Stepparent’s income and assets are also considered in FASFA forms and impact financial aid eligibility. Their own children can also have an impact especially when their kids are enrolled at least halftime in college, it can reduce the expected family contribution (EFC). Going from one child in college to two is like dividing the parent income in half.
Today college costs greatly affect family finances both in traditional and divorced families. They deserve great consideration in both circumstances, with divorced families needing to give a little more!