At this time of year when high school students apply to the colleges of their dreams and matriculates return to their studies, it is important to consider your own situation and how you might be able to provide the funds to assist your children or grandchildren with their education.
When a person sits down to do estate planning with an attorney or to discuss strategy with a financial planner, many people desire to provide some kind of legacy for the family. Oftentimes, the legacy comes in the form of the desire to ensure the family has access to a high-quality education. The concept starts like this: “I want to set up a trust so that I can pay for my grandchildren’s college.” But, after a more thorough discussion, the main goal is to provide some kind of funds to help pay for college whether it is in a “trust” or not in a trust. So, is it better to put some money in a trust in your will? Or, should you use a 529 plan?
What are they?
A 529 Plan is an education savings plan operated by a state or educational institution designed to help fund college by offering tax advantages. Created in 1996, these plans are named after Section 529 of the Internal Revenue Code. It was created by Congress and provides that earnings are not subject to federal tax when used for qualified educational expenses.
A trust is a tool that allows a person (Grantor) to put money or other assets into a vehicle (the trust) for the benefit of another person (the beneficiary). The trust is often incorporated in your will by directing that certain assets or property are to be distributed to, for example, The Grandchildren’s Educational Trust.
How are the options similar?
Both options provide a mechanism to fund college. Both can also be invested. They each provide some form of restriction on the use of the funds. They can both pay for all kinds of higher education expenses including tuition, fees, supplies, books, and room and board. And, with both, you have some flexibility in changing the beneficiary (for example, transferring the benefit to a sibling).
How are the options different?
There are many differences in the options. A trust is usually established in your Will and only effective upon your death (a testamentary trust). Unlike the 529 plan, a trust requires the expertise of an attorney to draft the trust terms. And, once effective, all trusts have certain administrative requirements such as: (1) a “Trustee” who is typically paid a fee to manage the trust; (2) certain annual reporting requirements to keep the trust beneficiaries informed of the trust; and (3) annual tax return filings. It is also important to note that trusts generally pay the highest level of income taxes and they enjoy none of the tax-free growth that the 529 College Savings Plans enjoy.
The trust provides the greatest flexibility in administering and distributing assets to the beneficiary. The trust can be used to provide funds to the beneficiary much more broadly than the 529 College Savings Plan. Indeed, it can be used for virtually any reason the Grantor (the person setting up the trust) can dream up: a down payment on a house, to pay for a marriage, to pay health care expenses, to encourage savings by contributing matching funds to a savings account, to pay for schools that are not authorized by the 529 plan (though generally any school that qualifies for federal financial aid qualifies for the 529 plan), etc.
Though there is no specific limit on contributions to the 529 plan, if you contribute more than $14,000 in any given year to a child’s 529 plan (or $28,000 for a married couple), you may have to file a gift tax return and potentially even pay gift tax. But, you should note that there is also the opportunity to report contributions to 529 plans over a 5-year period which increases the amount you can contribute without needing any gift tax implication). The testamentary trust has no such similar requirement.
How do I decide which to use?
One key decision in determining which method to use is to decide when you want to fund the education? If you are not in a position to dole out $14,000 per beneficiary right now, but your estate has assets that could be used to fund education after your death (think house and cars and other assets) and the beneficiaries are not going to college anytime soon then it might be best to set up the testamentary trust to fund education. If instead, you do have cash sitting around and you’d like to make current gifts, the 529 plan might be the best choice. Generally, the 529 plan is simpler to set up and administer than the trust and generally it is less costly than the trust.
* Licensed, not practicing.
The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual or entity. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment Advice offered through Cornerstone Wealth Strategies, Inc., a registered investment advisor and separate entity from LPL Financial.