Education Funding, Financial Planning

Preventing a Parent from Raiding Their Child’s College Savings.

Relatives and divorced parents often want to fund a child’s college savings account, but fear the money will be inappropriately spent by a manipulative or irresponsible parent. This post will discuss how to ensure the money will be used strictly for college, and how to avoid legal entanglements with the parent(s).

Situations often arise where a family relation wishes to provide financial assistance to a child for college, but they worry an irresponsible parent will manipulate the child or fraudulently gain access to the money and use it personally. These situations typically manifest with divorced couples, as well as grandparents/aunts/uncles wishing to contribute college savings for a child with negligent parents.

The best way to keep the parent(s) from accessing the funds is to ensure that the child never has control of the funds. This way, the parent cannot manipulate the child into giving them money. Plus, if the child has ownership of the funds, it is easier for the parent to fraudulently access the child’s account because they likely have all of the required personal information. Here are ways a contributor can maintain ownership of the assets:

Pay the college expenses directly.
This is obvious, but the obvious is worth pointing out. If the student is already attending college, you can pay the institution directly. The student or parent never has access to the funds. This solution does not address saving for a future college date for a child or newborn.

Open a Section 529 Plan, also known as a Qualified Tuition Program (QTP).
529 plans have exploded in popularity due to their income tax and estate planning benefits. They are also great vehicles for keeping control of your contributions. You are the owner of the plan, not the child. Additionally, the account owner has the ability to change the beneficiary of the plan to another family member. There are two types of 529 plans:

Prepaid Tuition Plans (such as Florida Prepaid)
With these plans, contributors prepay future tuition at today’s tuition rates. When the student attends college, the funds are paid directly to the college or university, so the student or unscrupulous parent cannot gain access to the funds. These plans usually require the designated beneficiary to attend a college in the state, although the covered amount may be ported to a private university or out-of-state school. This could create some snags. Florida Prepaid, for example, requires proof of residency in the form of a copy of one parent’s driver’s license. If you are not on speaking terms with the parent, this may not be obtainable.

College Savings Plans
The differentiating feature of a College Savings Plan is the owner bears the investment risk and the plan can cover any college expense anywhere. No proof of residency from the parent is required. The contributor can pay college expenses directly from the fund. The contributor is the owner of the fund, and the beneficiaries do not gain access to the funds when they enroll in college.

Avoiding a lawsuit by staying away from custodial accounts.
If you are worried about contributed money being squandered, stay away from custodial accounts, such as UGMA and UTMA accounts. These accounts are owned by the child and they gain access to the funds at age 18. This affords a manipulative parent plenty of opportunity to access the funds.

If you already have established a custodial account, it may be tempting to attempt to convert it to a 529 account. If a 529 account is funded with UGMA/UTMA money, the child becomes the owner of the account at 18 and the money cannot be transferred to another beneficiary like it typically could be under a 529.

If you attempt to take money out of the UGMA/UTMA account and put it in an account titled in your name (even if you think it is in the child’s best interest) you could be opening yourself up to civil (and possibly criminal) liability. Once money is placed in a UGMA/UTMA account, it is an irrevocable gift. You cannot take the money back for any reason. Imagine if a manipulative parent found out about this? You could be forced to repay the funds taken, reasonable lost investment return, and legal fees.

A note about 529 plans: The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.