Many people look to set up Section 529 plans to provide higher education funding for their family’s future use. In so doing, questions sometimes arise as to whether these funds are protected from creditors. Generally, a determination of whether protection is provided depends on the state in which the plan’s participants reside.
Section 529 plans are named after Section 529 of the Internal Revenue Code, a provision of the Code covering qualified tuition programs. The plans are sponsored by states and/or educational institutions, and allow tax-advantaged savings for future college costs incurred by the plan’s beneficiary. Basically, the amounts contributed to a Section 529 fund are allowed to grow tax-free under the Section 529 rules.
Three principal parties are involved with Section 529 accounts: the account donor, the account owner, and the account beneficiary. An account donor contributes funds to the account. Each Section 529 account also has an account owner, who manages the use of funds contributed. The account donor and account owner will often, but not always, be the same person. Typically, the account owner is a parent of the account’s beneficiary. The beneficiary of the account is the party for whose future use funds are invested. Beneficiaries of an account can be changed if changed circumstances arise (i.e. the beneficiary decides not to attend college, or receives a substantial scholarship). Of note, contributions to a Section 529 plans by parents or grandparents for a child’s benefit are deemed to be completed gifts, and are not included in the account donor or owner’s estate for estate tax purposes.
Protection of Section 529 plans from creditors is a state-specific issue, with slightly over one-half of states providing some type of protection. Under New Jersey law, funds in a Section 529 account are granted protection from creditors of the account donor and the beneficiary. However, protection is not explicitly provided for the account owners. Other states, such as Pennsylvania and Florida, explicitly provide this protection.
New York offers more limited protection for Section 529 plans than New Jersey. If the owner of a New York account is not both a minor and the account’s beneficiary, only $10,000 of the account balance will be protected from creditor claims. The remainder of the account’s funds will not be protected.
In most states, creditor protection for 529 accounts is provided only for accounts established within the state. A few states (such as Florida, Texas, and Tennessee) have statutes which could potentially offer protection to Section 529 plans established under the laws of any state. For example, a resident of Florida who holds an account in New York may be offered protection by Florida law. However, New Jersey and New York’s respective statutes follow the typical approach of only protecting plans established within the state.
The level of protection which can be provided to a resident of one state who holds a 529 plan in a different state is unclear. As an example, a New York resident establishing a 529 account under Florida law will not receive protection in New York (as mentioned above), and also may or may not receive protection in Florida. A determination as to whether protection would be granted under these circumstances would be made under Full Faith and Credit principles. However, different standards are used for different Full Faith and Credit decisions. This issue has not yet been tested in Court decisions. Because of this level of uncertainty, establishing Section 529 plans in the state in which the participants reside appears to be the safest route to ensure some level of protection.