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If you are considering bankruptcy or have already decided to file, your thoughts are likely drifting toward the fate of your savings. In particular, those who file bankruptcy often question how the decision will affect college savings accounts. This is your inside look from our Massachusetts bankruptcy attorney at how the formal admission of financial destitution affects college savings accounts.
The Impact of Filing Bankruptcy on College Savings Accounts
There is a common misconception that the entirety of one’s savings are forfeited when filing for bankruptcy. In reality, payment plans are agreed upon to gradually pay creditors over time. If you have created a 529 college savings account for your child, the money in that account is considered your property as opposed to your child’s.
The catch is that the United States federal bankruptcy code carves out an exclusion for 529 college savings accounts. The money in this type of account is excluded when the remaining property is liquidated during the bankruptcy process.
The funds within 529 college savings accounts cannot be collected by creditors and trustees. Therefore, if you file either a Chapter 7 bankruptcy or a Chapter 13 bankruptcy, the money in your child’s 529 college savings account will be off-limits.
Be Careful When Moving Money into 529 College Savings Accounts
You might be tempted to move non-college savings into your child’s 529 college savings account leading up to bankruptcy to safeguard as much money as possible. However, doing so is a mistake.
If you transfer money into the 529 college savings account prior to declaring bankruptcy, you will likely be penalized. In general, funds transferred into such college savings accounts within the year prior to bankruptcy are not protected.
Moreover, $6,225 per beneficiary transferred to the account between the year and two years leading up to bankruptcy is exempt from seizure. The logic in establishing such a rule is to prevent parents from using their kids’ college savings accounts to protect money that won’t be used for college costs.
College Savings Account Exclusion
The United States Bankruptcy Code’s section 541(b) states funds within 529 college savings plans are excluded from bankruptcy. The balance in the account is generally excluded from the bankruptcy estate. However, there is also an opportunity to exempt the account’s balance.
Assets that are excluded are not identified on a filer’s bankruptcy schedule. Alternatively, exempted assets are named on the schedule yet protected to a certain dollar value.
When in doubt, opt to file Chapter 13 bankruptcy instead of Chapter 7 bankruptcy. Filing Chapter 13 safeguards the entirety of college savings funds in 529 accounts and also provides broader protection for other assets.
Explore Alternative Financial Strategies to Protect Your College Savings
While bankruptcy can provide relief, it’s not the only option. Before filing, consider other strategies that might help manage your debt while safeguarding your college savings.
Debt Restructuring and Settlement
Debt restructuring involves negotiating new terms with creditors, such as lower interest rates or extended payment periods, making debt more manageable without touching your 529 account. Debt settlement, where you negotiate to pay off debts for less than the amount owed, can also be a viable option, especially if creditors are willing to settle rather than risk receiving nothing in bankruptcy.
Credit Counseling and Direct Negotiation
Credit counseling agencies can help you create a debt management plan, possibly reducing your monthly payments and avoiding bankruptcy. Additionally, directly negotiating with creditors might result in modified payment terms or even partial debt forgiveness, providing relief without resorting to bankruptcy.
Debt Consolidation
Consolidating your debts into a single loan with a lower interest rate can simplify payments and potentially free up funds to continue contributing to your child’s college savings.
Learn More During a Consultation With a Massachusetts Bankruptcy Attorney
Filing bankruptcy is a complex process that requires the guidance of an MA bankruptcy attorney. If you are considering filing for bankruptcy or starting the process, schedule a consultation with our law office today.