In the case of bankruptcy, creditor protection for Section 529 Education Savings Plans is provided by federal law, with significant limitations, under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This act excludes from property of the estate all contributions deposited toward a Section 529 Plan 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 the 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 the bankruptcy filing, Section 529 assets are protected up to $5,000 per beneficiary. These provisions apply to bankruptcy cases filed on or after October 17, 2005.
But what happens to Section 529 Plans if you are a California judgment debtor and have not filed for bankruptcy?
In addition to the federal bankruptcy protections described above, some states have passed statutes that protect Section 529 Plan assets from judgment creditors' claims brought outside of bankruptcy proceedings. However, California is not one of the states that has passed legislation specifying that Section 529 Plans are protected from the creditors of the beneficiary, contributor, and/or the account owner.
In a recently decided appellate decision (April 21, 2016), the Second Appellate District of the State of California held, in a case brought by our firm, resulting in a decision in favor of our client, that Section 529 Plans are not exempt assets under California's comprehensive judgment creditor statute (codified in Code of Civil Procedure sections 680.010 through 724.260). Specifically, in AMBS Diagnostics, LLC v. Timothy O'Brien, the Second Appellate District Court reversed a trial court ruling holding that a judgment creditor's Section 529 Plans were exempt assets similar to private retirement plans.
The appeal, filed by attorneys Paul D. Woodard and Marc S. Schechter of Butterfield Schechter LLP and Thomas M. Monson of Miller, Monson, Peshel, Polacek & Hoshaw, asked the Court to determine (1) whether Section 529 Savings Accounts are exempt from levy under California's enforcement of judgments law and (2) whether the trial court abused its discretion in exempting the full amount of the debtor's IRA accounts.
The Second Appellate District ruled that the trial court erred in exempting the judgment creditor's Section 529 Plans from execution of levy. This case was a matter of first impression and provides clear guidance to other California trial courts how to rule on a judgment creditor's claim of exemption over Section 529 Plans.
The Court wrote:
Is money that a person sets aside for the “qualified higher education expenses” of his children under Internal Revenue Code section 529 (so-called “section 529 savings accounts”) exempt from the collection efforts under the California Enforcement of Judgments Law, Code of Civil Procedure section 680.010 et seq., of a creditor who has a valid judgment against that person? We conclude it is not.
Ultimately, the Court opined that the four Section 529 savings accounts were not exempt from levy under California's enforcement of judgments law and, with respect to the trial court's finding of full exemption for IRA accounts in a non-bankruptcy setting, that the trial court applied the wrong standard by failing to “weigh or take into consideration [the debtor's] current wages given that the debtor was still many years from retirement, is in good health, and has earned a significant salary in the past.”