College Funds and Bankruptcy: How to Safeguard Your Child’s Future

Bankruptcy serves as a last resort after a long road of financial trouble. Chapter 7 works to eliminate debt while Chapter 13 works to restructure payments for those who can manage them. Regardless of your chosen type, both have the power to wipe out your financial assets—including your child’s college fund.

 

Higher education costs are vast and growing. In 2010 alone, the average price of a public university rose to $7,020; a 6.5 percent increase from the last year. With prices expected to rise at an average of 5-8 percent each year, parents are taking a closer look at how to provide their kids with the funds necessary to earn a degree. For those filing for bankruptcy, the threat of losing a hard-earned college fund to bankruptcy trustees is devastating. Luckily, there are ways to ensure your son or daughter’s future without sacrificing bankruptcy protection.

 

National Legislation

In response to this glaring bankruptcy issue, the Uniform Gifts to Minors Act (UGMA) was enacted as a way to help parents. Adopted by the majority of U.S. states, this legislation provides parents with a way to protect their children while filing for bankruptcy. It allows assets to be held in the parents’ name on behalf of their child until the age of 18 or 21. Once the child reaches the appropriate age, they gain control over the account and may withdraw funds at their discretion. The UGMA allows college funds to act similarly to trust funds without the need for an attorney to officially appoint a trustee.

 

Savings Plans

While the UGMA offers protection for most states, reciting rights not enough for those filing for bankruptcy. To guarantee protection, many utilize their rights to transfer mutual fund and IRA money into an education-specific 529 College Savings Plan. Offered by states and universities alike, 529 Savings Plans are tax-sheltered accounts that focus on educational savings only. Parents have the option of contributing to these interest-bearing accounts during bankruptcy proceedings without the fear of fund confiscation. Why? Because 529 withdrawals may only be used for educational purposes. Of course, there are a few downsides to investing in a 529 plan, including:

  • Penalties for withdrawing the funds before a child reaches 18 or 21 (depending on the state laws)
  • Investing a surplus amount with no way to use the funds for other purposes (without facing a 10 percent penalty, plus additional taxes and fees)
  • Less freedom to invest compared to a mutual fund
  • Funds could affect financial aid eligibility

Despite the potential drawbacks, ensuring the safety of your college funds far outweighs the negatives.

 

Saving for college is a major investment in your child’s future. While your present financial troubles threaten the stability of everyday life, it should never threaten your kid’s ability to learn. Take proactive steps to protect your hard-earned college savings. Your kid’s future depends on it.

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