“After inheriting a considerable sum of money, an elderly matriarch of a New England family decided that the best thing she could do for her clan’s younger generations was to establish savings for their college education.”
The reason was to have more flexibility. The 529 account limits how much can be invested, where the money can be invested and how the assets must be used. A trust provides far more options.
However, these two options—the 529 and the trust—can be used in a combination that offers the best of both worlds. Let’s look at them both.
The 529 plan is great for tax-deferred asset growth. Funds can be taken out tax-free, as long as they are used for qualified educational expenses. As a result of changes to the law from the recent tax reform, you can use 529 funds for qualified educational expenses for elementary, middle, and high school tuition. For families sending their kids to private schools, this was a great change.
Investment options for 529 accounts are mutual funds or pre-designed portfolios that become more conservative, as the beneficiary gets closer to attending college. Investment caps are generally about $300,000 for the entire life of the plan, as opposed to annually.
If the funds are used for expenses that are not qualified, like buying a car for a student who will be living off campus and needs a car to get to and from school, there will be a 10% penalty on earnings and taxes to be paid.
A trust offers far more flexibility for all concerned. If the money is not completely used for education, the trustees might wish to give the child money for a down payment on a home, or to start up a business. The rules are set by the person creating the trust. You can even require the student to maintain a certain grade point average. The owner of the trust also determines who will pay taxes on the appreciated assets in the trust—the owner of the trust, the trust itself, or the beneficiaries.
Another tactic is to use the annual gift-tax exclusion to fund a 529 plan and put the balance of the money dedicated to a child’s college fund into a trust.
Like an estate plan, this type of college funding plans should be reviewed on an annual basis to ensure that it is adjusted, as needed.
Reference: Penta (September 2018) “There’s A Better Way to Fund a College Education”