In New Jersey, both parents are responsible for the support of their children, including contributions toward college education. Many times, parents begin saving for college education while their children are young by investing in 529 College Savings Plans or Custodial Accounts.
It is important to note the differences between these two types of accounts since it may affect the vehicle you chose if you are getting divorced.
Custodial accounts are accounts established at a financial institution for the benefit of a minor child. Generally, one of the parents is named as the custodian for the benefit of the child under the Uniform Transfer to Minors Act (previously the Uniform Gifts to Minors Act). These accounts belong to the child, not the parent. By establishing this type of account, the parent(s) made an irrevocable gift to the child. While the parent, as custodian, may make the decision as to how the money will be invested and spent (until the child is 21), the money must nevertheless be spent for the child or turned over to the child at age 21.
It must also be noted that when using funds in a custodial account, that payment is in addition to, not in substitution for, any obligation of a person to support that minor. It is well settled law in New Jersey that a child’s assets may not be used to fulfill a parent’s support obligation.
A 529 Account is a college savings plan which has tax advantages authorized under IRC
Section 529. These plans allow an investor to save money in an account in which the earnings (i.e., interest, dividends) will grow tax free and, when used for qualified higher education expenses, may be withdrawn tax free.
Anyone can be named as a beneficiary regardless of their relationship to the owner, and anyone can contribute to the account. Only one account owner can be named on the account.
Since this type of account is owned generally by a parent (and not the child), this asset must be dealt with in any Property Settlement Agreement during a divorce. Since the account is only in one party’s name, the best way to deal with it is to split it equally between the parents to assure that each party has control or ownership of an equal amount. Since divorce agreements many times include provisions for the allocation of college education expenses when they arise, each party can then plan for their own contribution in the future by continuing to invest in their own 529 plan or at least continuing to hold the asset.
It should be noted that an owner of a 529 account can make unqualified withdrawals (withdrawals for any reason) as long as they pay the tax and penalties associated with the withdrawal. Therefore, it is not preferable to keep the account in one party’s name after divorce with just a promise that he/she will use the account for your child’s college education expenses.
Further, if only one party holds the asset and there were no specific terms in the Agreement relating to this account, the owner/parent may argue that these funds will go only toward his/her share of the obligation for college education, and the other parent will receive no credit.
It is best to be very explicit in your Property Settlement Agreement with regard to funds saved and intended for college.