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Bankruptcy Protection and 529 Accounts

Protections of 529 assets from creditors in the case of bankruptcy vary by state.

Susan T. Bart, 10/26/2012

Creditor protection for section 529 savings accounts is provided by federal law in the case of bankruptcy (with significant limitations) and in at least 27 states by statute or regulation in the case of creditors' claims generally (which includes creditors' claims brought outside of bankruptcy proceedings).

Federal Bankruptcy Protection
Section 529 accounts generally will not be subject to the claims of creditors in the event of the bankruptcy of the beneficiary if the beneficiary is not the account owner because the beneficiary does not have any legal or equitable interest in the account.

In the event of the bankruptcy of the account owner, the 529 savings account may be subject to creditors' claims because the account owner does have a legal or equitable interest in the account. However, all or part of the account may be excluded from the bankruptcy estate by federal law, or may be exempt by special state bankruptcy exemptions.

In the event of the bankruptcy of the donor to a 529 savings account who is not the account owner of such account, the donor does not have a legal or equitable interest in the account but, depending upon the circumstances, the 529 savings account may be included in the bankruptcy estate under the fraudulent conveyance rules.

Exclusions From Bankruptcy Estate. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the "2005 Legislation") provides some significant exclusions from the bankruptcy estate for contributions to 529 savings accounts for certain family members where such contributions were made at least two years prior to bankruptcy, and limited protection for contributions to such accounts made between one and two years prior to bankruptcy.

Bankruptcy Code section 541(b)(6) provides that contributions made to a 529 savings account for a child, grandchild, stepchild, or stepgrandchild more than two years prior to filing the bankruptcy petition are protected to the extent they do not exceed the amounts permitted to be contributed per beneficiary by the program.

Funds contributed to a 529 savings account for a child, grandchild, stepchild, or stepgrandchild more than 365 days but less than 720 days prior to filing bankruptcy are protected only up to $5,850 per beneficiary.

Contributions made to a 529 account within one year prior to a bankruptcy filing, however, are included in the property of the estate.

Susan T. Bart is a partner in the Private Clients, Trusts & Estates Group at Sidley Austin LLP in its Chicago office, where her practice includes estate planning, estate and trust administration, and fiduciary counsel. She has written two books, including Education Planning and Gifts to Minors published by Illinois Institute for Continuing Legal Education (iicle.com), which extensively discusses 529 plans.

She is the author of Education Planning and Gifts to Minors 2004 Edition. She is a frequent speaker on trust and estate topics in general and Section 529 college savings plans in particular.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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