Using a trust versus a 529 plan for education

A quality education is one of the greatest gifts you can give a child. To make that possible, many families have turned to 529 plans, which offer attractive benefits including tax-free growth, state tax-deductible contributions (depending on state), and the flexibility to change beneficiaries. These popular college savings plans also offer another advantage — the ability to front-load up to five years of annual exclusion gifts. That means with the annual exemption of $15,000, you could set aside a total of $75,000 per grantor. You will, however, be unable to make annual gifts during the current year and the next four years.

For those concerned about estate taxes, there may be another alternative for financing educational expenses — irrevocable trusts.

An education funding and estate-tax reducing solution

While 529 plans have their benefits, they do have limitations. One limitation is that any contributions you make beyond the annual exclusion will be applied toward your lifetime gift and estate tax exclusion, currently $11.4 million. For those who require estate tax planning strategies, this could be a problem. There is, however, another solution: using an irrevocable trust to fund educational costs and reduce future estate taxes. Here's how it works:

1. You fund an irrevocable trust for the benefit of the child by using annual exclusion gifts (up to $15,000 per year).
2. You then use funds from that trust to make qualified transfers to cover educational expenses. These qualified transfers are payments you make directly to the educational institution — not the student — so they're not counted toward your annual or lifetime gift exclusion.

Benefits of using a trust for college funding

Using an irrevocable trust versus a 529 plan offers a variety of benefits, including:

• Investment flexibility. Trusts can be invested in a wide array of vehicles, whereas 529 plans offer limited options.
• Distribution flexibility. While 529 plans must be used solely for educational purposes, trusts can be constructed to allow for the distribution of assets for purposes other than education, including medical expenses, maintenance, and support.
• Asset protection. Assets can remain in the trust even after the student finishes school, protecting funds from creditors, divorce, and reckless spending.
• Life insurance protection. Trusts can also hold a beneficiary's interest in other family wealth transfer vehicles, including life insurance.

Consult with an experienced professional

Given the complicated nature of estate planning, I strongly recommend you consult with an experienced professional. They can help you evaluate the benefits and drawbacks of each option, including the legal and compliance costs involved with trusts and the loss of income tax benefits from a 529 plan.

More information

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