Protect Your Child's College Fund From Debt Collectors
Written by: Kristy Welsh
Last Updated: July 19, 2017
If you have been saving for your child's education, the last thing you want is for a debt collector to take it all away. But can they? Are college savings accounts safe from creditors? What if you are sued by a creditor and you lose — can they collect the money owed by tapping into your son or daughter's college fund? These are all scary possibilities and ones that need to be planned for far in advance of collection proceedings or bankruptcies. If you are thinking of starting a college fund for your child, or if you already have one in place, you need to make sure it is set up properly so that it does not become fair game for debt collectors or the court system.
Are College Savings Accounts Safe?
We hate to be vague, but the answer to that question is "it depends." It depends on the way the money has been socked away, your state laws, and even how recently savings were put into the account. The most popular type of college savings account is the 529 savings plan. This type of account has 3 parties involved: the owner (parent), the contributor (most likely the parent), and the beneficiary (the child). Now, here is where it gets a bit muddy. State laws vary with regard to whose interests are protected if there is a judgment brought up as a result of a bankruptcy or a lawsuit. In some states, for example, if there were a judgment against the beneficiary, funds would be protected. But if the contributor lost a lawsuit, that money might be at risk. State laws change so be sure to consult an attorney for specific advice.
Set Up Savings Account Properly
One way to protect the money you are saving for your child's college education is to put it into a trust, more specifically, an irrevocable children's trust (ICT). This type of trust can contain a variety of assets without the limitations of a 529 savings plan. Also, this trust can be earmarked in whole or in part to cover educational expenses other than simply tuition.
But, in order to protect the assets of the trust from creditor's claims, it must be set up properly. It requires a grantor, a beneficiary, and a third-party trustee who is neither the grantor nor the beneficiary. Our best advice to you would be to contact either a well-qualified financial planner or an estate attorney to set up this trust. Depending on your net-worth, size of the savings account, and possibly other assets you want to include in the trust, your best bet it to have an experienced person do all of this for you. You want to make sure you present all possible scenarios to your attorney so that you have the best protection for your money.
No one likes to think of the possibility of being sued or filing for bankruptcy, but you never know what could happen in your life in the next 5 to 10 years. What you don't want to have happen is to find out you are facing a lawsuit or bankruptcy and then try to dump money into these savings strategies after the fact. This will probably backfire for a couple reasons;
- There are limits on how much can be contributed to the plans without running into gift tax issues.
- This type of action may be considered "fraudulent conveyance," which can make a bad situation even worse.
In the case of bankruptcy, there is a "look-back period" during which transfers made too close to the bankruptcy filing can be reversed and you might lose all that money to pay off your creditors. Of course, even the best-laid plans can not foresee a serious illness, natural disaster, or unemployment, but if you being proactive about saving for your child's education take the time to plan ahead. Always consult with a financial planner to make sure you are structuring everything correctly so in the event of a catastrophe, your child's money will be safe.
Know Your Rights When Dealing with Debt Collectors
Lastly, knowing your rights when dealing with debt collectors is crucial. If a debt collector threatens to take your kid's college fund, it may be an illegal threat under federal law. The FDCPA (Federal Debt Collection Practices Act) does not allow collectors to threaten things they cannot do. And, since these accounts are off-limits to them, such a threat is a violation of the FDCPA and you may be able to sue them for breaking this law. If you know your rights, you won't be pressured into paying debts you don't owe, or using money you have saved for other purposes.