If I declare bankruptcy, what will happen to tuition prepayments for my children?

Tuition prepayments are structured in varying ways. In some situations, money is actually paid to a school or group of schools. In other instances, you may have money in a 529 account, a trust fund or have it set aside in some other way for your children. In the case of a bankruptcy, what happens to that money is going to depend on the tuition prepayment plan’s structure and on the bankruptcy chapter filed.

If you file a Chapter 13 bankruptcy, your tuition prepayment is not going to be impacted in any way by your bankruptcy. A Chapter 13 bankruptcy is different from a Chapter 7 in that there is no requirement that any of your assets become part of a bankruptcy estate that is distributed to your creditors. However, while you get to keep all of your money and possessions, your debt is also not simply forgiven; instead, you must repay some portion of your debt through a repayment plan that is approved by your creditors and that lasts for between three and five years.

If you file a Chapter 7 bankruptcy, however, it is possible your tuition prepayment could be considered an asset that you would need to release for distribution to your creditors. As a general rule, if you have the ability to revoke any sort of trust arrangement or to direct payment of the money to yourself, your creditors can reach the money you have set aside. This is true even though these plans generally get favorable tax treatment despite their revocability options. Their treatment in bankruptcy may not maintain such advantages if the plan is in your name and is in any way accessible by you. In the latter case, the exemptions available in your state will determine how much – if any – of the money you may keep.

However, if the money has already been paid to the school, or if it was transferred solely into your child’s name long ago, it may not be reachable.

You should contact an attorney in your area for advice about whether funds you pay under such a plan are beyond the reach of your creditors. A bankruptcy lawyer can help you to determine what will happen to your account and can also help you make important choices like whether Chapter 7 or Chapter 13 is the appropriate chapter of bankruptcy for you to file.

Case Studies: What happens to tuition prepayments in bankruptcy?

Case Study 1: Chapter 13 Bankruptcy

John, a parent who filed for Chapter 13 bankruptcy, had made tuition prepayments for his children’s education. In Chapter 13, the tuition prepayment is not impacted, as assets are not included in the bankruptcy estate. This means that John can retain the funds allocated for tuition and continue making payments towards his debt through a court-approved repayment plan.

The advantage of Chapter 13 bankruptcy is that it allows individuals to reorganize their debts and maintain control over their assets while fulfilling their financial obligations.

Case Study 2: Chapter 7 Bankruptcy

Sarah, a parent facing financial difficulties, filed for Chapter 7 bankruptcy. In this case, Sarah’s tuition prepayment may be considered an asset subject to distribution among creditors. Since Chapter 7 involves the liquidation of non-exempt assets to pay off debts, Sarah’s ability to retain the tuition prepayment would depend on the exemption rules applicable in her state.

If the prepayment can be exempted under the state’s bankruptcy laws, Sarah may be able to protect those funds from being used to satisfy her debts. However, if the prepayment is not exempt, it may be required to be included in the bankruptcy estate.

Case Study 3: Trust Fund Protection

Michael, a parent who established a trust fund for his children’s tuition, filed for Chapter 7 bankruptcy. Since the trust fund is irrevocable and solely designated for his children, it is likely protected from being reached by creditors. Irrevocable trusts often provide a level of asset protection, as the funds held within them are considered separate from the debtor’s estate.

As long as the trust fund was properly established and the beneficiaries are clearly defined, it is less susceptible to being included in the bankruptcy estate and can be preserved for the intended purpose of paying for the children’s education.