Policy and Practice Working Paper. April 2007 Volume 1 Issue 4. State Creditor Protections for 529 Plans. Written by Barbara Rosen

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1 Policy and Practice Working Paper April 2007 Volume 1 Issue 4 State Creditor Protections for 529 Plans Written by Barbara Rosen

2 Introduction As part of the larger Saving for Education, Entrepreneurship, and Downpayment (SEED) Initiative, state policy partners in five states are working to develop policies to create or expand progressive savings opportunities for children. The goal of these partnerships is to invest in state efforts that have a real possibility for a public policy breakthrough within five years. In this process, the selected state policy partners are responsible for leading state policy development, advocacy efforts and constituency organizing in their state. CFED supports these efforts by providing access to comprehensive research findings for use in policy advocacy; opportunities to share lessons with other partners at semi-annual meetings; and assistance with communications, research, policy development, and advocacy. During the October 2006 SEED state policy partner meeting in New ork City, CFED received inquiries about state creditor protection laws for 529 plans. These laws protect the assets in a 529 plan from the claims of creditors who are seeking repayment for outstanding debts. CFED has issued this paper that outlines which SEED state policy partner states have creditor protection statutes in place, and how these regulations protect the savings of account owners, beneficiaries, and donors from attachment by creditors.

3 Summary of Findings In the case of bankruptcy, creditor protection for 529 plans is provided by federal law, with significant limitations, under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (see Appendix B). This act excludes from property of the bankruptcy estate all contributions deposited toward a 529 savings account for a beneficiary who is the child, grandchild, stepchild, or step-grandchild of the debtor, and as long as the deposits were made at least two years before bankruptcy was filed and they do not exceed the maximum amount permitted per beneficiary for the program. If the contributions were made between one and two years prior to bankruptcy filing (for certain family members, see above) 529 assets are protected up to $5,000 per beneficiary. These provisions apply to bankruptcy cases filed on or after October 17, 2005 (180 days after enactment of the Bankruptcy Act). In addition, specific creditor protections for Section 529 Plans are mandated by the states; currently at least 27 states have passed statutes that protect accounts from creditors claims more generally, including those claims that have been brought outside of bankruptcy proceedings. This paper provides information about the current creditor protection statutes for 529 plans in the SEED state policy partner states (Arkansas, California, Illinois, Kentucky, Michigan, Oklahoma), as well as a chart that compares creditor protections in other states (see Appendix C). Thus far, Arkansas, Oklahoma, and Kentucky have passed statutes that protect 529 assets from the claims of creditors who are seeking repayment of debts. In comparison, Michigan, California, and Illinois have not passed creditor protection laws for 529 plans. Some of the state statutes specify that 529 savings accounts are protected from the creditors of the beneficiary, contributor, and/or the account owner (in the case of Arkansas and Kentucky). Other statutes protect 529 accounts from creditors claims more generally (Oklahoma), in which case it is presumed that the statute would protect the account from creditors of the account owner, beneficiary, and contributor. In the case of an account held by a custodian for a minor beneficiary, creditor protection would likely not be necessary, as minors generally cannot incur enforceable debts (with some exceptions). A statute that specifically protects an account from the creditors of a beneficiary may provide some protection in the event of a custodial account where the beneficiary incurs debts after attaining majority but before attaining the statutory age for distribution of a custodial account. 1 The statutes in Arkansas, Kentucky and Oklahoma include creditor protection for the beneficiary of the 529 savings account. Whether or not a resident of State A with an account in State B s 529 plan can rely on the debtor/creditor laws of State B is unclear. 2 The full faith and credit clause of the Constitution, Article IV, Section 1, provides: Full Faith and Credit shall be given in each State to the public Acts, Records, and judicial Proceedings of every other State. However, the courts have applied different levels of deference to conflicts of law principles, substantive laws and judgments under this clause. The full faith and credit clause does not compel a state to substitute the statutes of other states for its own statutes; subsequently, it is difficult to predict whether or not one state would honor the creditor protections for a 529 plan in another state, as this issue has not been tested in the courts. Currently Florida, Texas, and Tennessee are the only states that have statutes which provide creditor protection for 529 savings accounts established under any other state s program. 1 Bart, Susan. Creditor Protection for 529 Accounts. November 18, 2005, p.2. Online: 2 Hurley, Joe. 529s and the new Bankruptcy Act. April 29, Online: Bart, Susan. College Planning Q&A: More States Offer Creditor Protection. April 28, 2006, p.2. Online:

4 Appendix A State Creditor Protection Statutes and 529 Plan Descriptions Arkansas Arkansas law provides: (2) An account or any legal or beneficial interest in an account shall not be subject to attachment, levy, or execution by any creditor of an account owner or designated beneficiary. A.C.A (b)(2) Plan Program Description reads: NO ASSIGNMENTS OR PLEDGES Neither an account nor any portion thereof may be assigned, transferred or pledged as security for a loan (including, but not limited to, a loan used to make contributions to the account) or otherwise either by the Account Owner or by the designated beneficiary, except for changes of designated beneficiary, qualified rollovers, as described herein, and the transfer of Account Ownership to a successor Account Owner. Any pledge of an interest in an account will be of no force and effect. Neither an Account nor any legal or beneficial interest in an Account may be subject to attachment, levy or execution by any creditor of an Account Owner or designated beneficiary. 5 Oklahoma Oklahoma law provides for the following exemption: 1. Property exempt from attachment, execution or other forced sale Bankruptcy proceedings. A. Except as otherwise provided in this title and notwithstanding subsection B of this section, the following property shall be reserved to every person residing in the state, exempt from attachment or execution and every other species of forced sale for the payment of debts, except as herein provided: 26. Any interest in an Oklahoma College Savings Plan account established pursuant to the provisions of Section et seq. of Title 70 of the Oklahoma Statutes. 31 Okl. St. 1, A, Plan Program Description reads: Bankruptcy and Related Matters Pursuant to Oklahoma law, any interest in a Program Account held by an Oklahoma resident shall generally be exempt from attachment or execution and any other type of forced sale for the payment of debts in Oklahoma. This exemption, however, may not be enforceable or available to exempt an individual s interest in such an Account in such individual s bankruptcy proceedings in other states where other laws may apply. 7 4 Bart, Susan. Creditor Protection for 529 Accounts. November 18, 2005, p.3. Online: 5 Gift College Investing Plan, Program Description and Participant Agreement. February 2005, p.30 6 Bart, Susan. Creditor Protection for 529 Accounts. November 18, 2005, p.4, Online: 7 Oklahoma College Savings Plan, Disclosure Booklet and Participant Agreements, July 19, 2006, p.29.

5 Kentucky Section 164A.350(9) provides that for all purposes of Kentucky law: (9) Notwithstanding any other provision of law to the contrary, contributions and earnings on contributions held by the trust shall be exempt from levy of execution, attachment, garnishment, distress for rent, or fee bill by a creditor of the participant or the beneficiary. No interest of the participant or beneficiary in the trust shall be pledged or otherwise encumbered as security for a debt. Ky. Rev. Stat. 164A Plan Program Description reads: Bankruptcy and Related Matters Kentucky law generally provides an exemption from execution or attachment by creditors of a Participant or a Beneficiary on contributions and earnings on contributions in an educational savings plan account. Pursuant to Kentucky law, contributions and earnings on contributions in an Account shall be exempt from execution, attachment, garnishment, distress for rent, or fee bill by a creditor of the Participant or the Beneficiary of the Account who are resident in Kentucky for the payment of a debt owed to such creditor. This exemption, however, may not be enforceable or available to exempt an individual s interest in the Account in such individual s bankruptcy proceedings in other states where other laws may apply. Nor is it clear how or whether such exemption will be applied in a proceeding commenced against such individual in a court located in Kentucky. 9 Illinois, Michigan, California Illinois, Michigan, and California currently do not have creditor protection statutes for 529 plans in place (other than what is stipulated under the federal Bankruptcy Abuse Prevention and Consumer Protection Act of 2005). 8 Bart, Susan. Creditor Protection for 529 Accounts. November 18, 2005, p.4. Online: 9 Kentucky Education Savings Plan Trust, Program Disclosure Booklet, p.38

6 Appendix B Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (enacted April 20, 2005) The 2005 legislation excludes from property of the bankruptcy estate under Bankruptcy Code Section 541 (b): (6) funds used to purchase tuition credit or certificate or contributed to an account in accordance with section 529(b)(1)(a) of the Internal Revenue Code of 1986 under a qualified State tuition program [as defined in section 529(b)(1) of such Code] not later than 365 days before the date of the filing of the petition in a case under this title, but (A) only if the designated beneficiary of the amounts paid or contributed to such tuition program was a child, stepchild, grandchild, or stepgrandchild of the debtor for the taxable year for which funds were paid or contributed; (B) with respect to the aggregate amount paid or contributed to such program having the same designated beneficiary, only so much of such amount as does not exceed the total contributions permitted under section 529(b)(7) of such Code with respect to such beneficiary, as adjusted beginning on the date of the filing of the petition in a case under this title by the annual increase or decrease (rounded to the nearest tenth of 1 percent) in the educational expenditure category of the Consumer Price Index prepared by the Department of Labor; and (C) in the case of funds paid or contributed to such program having the same designated beneficiary not earlier than 720 days nor later than 365 days before such date, only so much of such funds as does not exceed $5,000. In addition, with respect to determining whether the 529 savings account beneficiary stands within one of the required relationships to the donor, the 2005 legislation adds the following provision to Bankruptcy Code Section 541: (e) In determining whether any of the relationships specified in paragraph (6)(A) of subsection (b) exists, a legally adopted child of an individual (and a child who is a member of an individual s household, if placed with such individual by an authorized placement agency for legal adoption by such individual), or a foster child of an individual (if such child has as the child s principal place of abode the home of the debtor and is a member of the debtor s household) shall be treated as a child of such individual by blood Bart, Susan. 529 Creditor Protection under 2005 Bankruptcy Act. June 24, Online:

7 Appendix C Table of Creditor Protections for 529 Savings Plans by State 11 State Statutory Exemption Limited to State s Own Program Statute Specifies Protection from Creditors of Account Donor Owner Beneficiary Exemption Inapplicable Child Support Divorce Other Limitations Alaska Alaska Stat Arkansas A.C.A (b)(2) Colorado C.R.S Florida Fla. Stat N Idaho Idaho Code A Kansas K.S.A (f)(2)-(4) Beneficiary must be lineal descendant of account owner. No protection for contributions made within one year before bankruptcy petition or judgment for claims. Contributions made between one year and two years prior to bankruptcy petition or judgment for claims only protected up to $5,000 per account owner. Kentucky Ky. Rev. Stat. 164A.350 Louisiana La.R.S G Maine Maryland Nebraska Me. Rev. Stat. Ann. title 20 A, Md. Education Code Ann R.R.S. Neb Nevada NRS Exemption is inapplicable if the money will not be used by any beneficiary to attend a college or university. 11 Bart, Susan. College Planning Q&A: More States Offer Creditor Protection. April 28, 2006, p.2. Online:

8 State Statutory Exemption Limited to State s Own Program Statute Specifies Protection from Creditors of Account Donor Owner Beneficiary Exemption Inapplicable Child Support Divorce Other Limitations New Jersey N.J. Stat. 18A:71B-41.1 Provides exemption for moneys paid out of an account for higher education expenses. New ork N CLS CPLR 5205 Exemption is very limited. See the statute. North Dakota N.D. Admin. Code (2005) Ohio ORC Ann (A) Oklahoma 31 Okl. St. 1, A, 26 Oregon ORS (2) Pennsylvania 24 P.S Rhode Island R.I. Gen. Laws (15) South Carolina S.C. Code Ann South Dakota S.D. Codified Laws No exemption for funds contributed by account owner or contributor within one year of filing bankruptcy petition. Tennessee Tenn. Code Ann N Texas Tex. Prop. Code N Virginia Va. Code Ann West Virginia W.Va. Code (i) Wisconsin Wis. Stat

9 Acknowledgements CFED would like to acknowledge Susan T. Bart for providing valuable information and guidance for this paper. About CFED Established in 1979 as the Corporation for Enterprise Development, CFED is a nonprofit organization that expands economic opportunity. We work to ensure that every person can participate in, contribute to, and benefit from the economy. We identify promising ideas; test and refine them in communities to find out what works; craft policies and products to help good ideas reach scale; and foster new markets to achieve greater economic impact. CFED works nationally and internationally through its offices in Washington, DC; Durham, North Carolina; and San Francisco, California. CFED 777 N. Capitol Street NE Suite 800 Washington, DC (p) (f)