Trusts can help you make a loved one’s education part of your wealth strategy.
A good estate plan will give you the peace of mind of knowing your assets will continue to provide for your loved ones when you no longer can. For many, that includes helping future generations with the costs of college, including books, supplies and daily living expenses.
“Incorporating saving for college in an estate plan can reduce the financial burden on families and children,” says Callie Morgan, Private Wealth planner at Regions Bank. “There are vehicles specifically for higher education that can help lower the financial stress for parents trying to figure out how they’re going to pay for college and how they’re going to retire.”
There are many ways to incorporate college planning into an estate plan, but one powerful strategy is using trusts. By making a college fund part of a larger trust for your estate plan, you can realize benefits, such as increased control over fund distributions for non-tuition-related expenses without penalty, greater flexibility upon completion of education, and more expansive investment options.
Still not sure whether you should include a trust in your estate plan to provide for education? Read on for answers to common questions about trusts and education planning.
What is a trust?
A trust is a legal entity that owns or manages assets on behalf of a person, multiple individuals, or one or more organizations. When you set up a trust and designate beneficiaries, you no longer own the assets you put into it. You can act as trustee and manage the trust yourself or designate a trustee—either a family member or a corporate trustee—who can manage the trust for you in the best interest of the beneficiaries. The trustee retains control of the assets until their distribution to the beneficiaries.
Trusts allow you to determine how money is distributed, to whom and when. Trusts also offer the opportunity to set clear designations for a portion of funds within a larger pool, making them a useful tool when it comes to working funding for college costs into your overall finances—including your estate and wealth transfer goals.
How do trusts compare to 529 plans for education funding?
When it comes to planning for education, 529 plans are a popular, tax-advantaged savings vehicle that many people use. These tools have several benefits, including that they’re simple to use and easy to set up. Assets in a 529 plan grow tax-free, and you won’t pay taxes on withdrawals if they’re used for qualified education expenses such as tuition, fees and books. You can also “front-load” 529 plans, meaning you can make five years’ worth of non-taxed gifting ($18,000 per year in 2024) up front. Note, however, that should the 529 account be overfunded, there is a 10% penalty for distributions not being used for qualified education expenses. Recent statutory changes allow you to roll over up to $35,000 in unused 529 funds into a Roth IRA for the beneficiary.
While front-loading is not an option for trusts, using your annual exclusion to fund a trust instead of a 529 plan leaves the door open for additional estate planning strategies in conjunction with the trust. This is particularly beneficial for ultra-high-net-worth families. Additionally, unlike 529 accounts, overfunding is not an issue for trusts.
Funds not used for qualified education expenses can be distributed without penalty. If your child does not pursue higher education or has money in the account available after completing education, surplus funds can be used for anything including a down payment on a home or to start up a business. Furthermore, trusts allow you to have multiple beneficiaries concurrently, whereas only one beneficiary is permitted per 529 plan at a time. Finally, trusts provide protections against divorce settlements, creditors and legal claims.
One potential downside of using trusts for college savings is that they often count toward a student’s assets, which might prompt colleges to reduce their financial aid awards. On the other hand, 529 plans generally count toward the parent’s assets instead of the student’s, which minimizes the impact on the student’s Free Application for Federal Student Aid (FAFSA).
Can I have a 529 plan within a trust?
Yes. Many 529 plans allow for a contingent owner to take over in case the owner becomes unable to manage the plan. Naming a trust as the contingent owner may work for grandparents who want the peace of mind of knowing their wishes will be carried out by their trustee. However, 529 plans can only have one beneficiary at a time, so you may need to take special care if the trust has multiple beneficiaries.
How do I set up a trust?
Since trusts are legal entities, you’ll want to work with an estate planning attorney to make sure that the legal document aligns with your wishes. They can work with your financial planner and tax advisor to come up with the best structure of the trust for your situation. Together, you and your team can determine the best investment strategy for the trust and appoint a trustee to manage it.
Morgan recommends also discussing the trust with the beneficiary when they’ve reached an appropriate age and introducing them to your advisors.
“Typically, it’s best to go ahead and create that relationship with the next generation and the financial advising team so they can understand what a trust is and how it works,” she says.
What type of trust should I use for education planning?
Several different kinds of trusts can make sense if your goal is funding education. The right trust for you will depend on your financial situation, goals and overall estate plan, but here’s a look at the most common:
- Grantor trusts. Grantor trusts. These trusts coordinate well with other estate planning strategies allowing the grantor to leverage their annual exclusion for both college savings and estate planning. This structure provides a flexible and tax-efficient way to fund a child’s education while simultaneously keeping the assets out of the child’s estate, offering both control and long-term financial security.
- Section 2503(c) trusts. These trusts are created to give the trustee control over the money until the beneficiary turns 21, enabling a parent or grandparent to ensure that the money is used for education expenses. Gifts to these trusts also qualify for the annual gift tax exclusion. These trusts do, however, require an attorney to draft a trust document, which increases the setup costs. Also, they are considered an asset of the child for financial aid purposes.
- Health and education exclusion trusts (HEETs). You can use a HEET to pay for the medical and education expenses of grandchildren or their descendants. If you fund a HEET while you’re still living, it’s an irrevocable trust, so the assets that fund the trust are not considered part of the donor’s estate. However, HEETs do require at least one beneficiary to be a charitable organization.
Bottom line
Incorporating college funds for your next generation with a trust or 529 plan may help reduce your tax burden while simultaneously providing for your descendants’ education expenses. Work with a financial professional to determine which vehicle is a more appropriate strategy for your overall financial plan.
Talk to your Regions Wealth Advisor about:
- How much you should be saving for your family’s education needs.
- Whether a trust might be appropriate for your college-saving goals.
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