If you’re saving for your child or grandchild’s college education, you should consider options like a 529 plan, an education savings account (ESA) or an irrevocable trust. Each has its own benefits and drawbacks, making it important to choose the one that best fits your financial goals and family needs.
In part one of this series, we discussed 529 plans and education savings accounts, which are popular options for saving for college education due to their tax benefits. However, both come with restrictions. Funds must be used strictly for education-related expenses and investment options are generally limited to mutual funds. These limitations can make 529 plans and ESAs less suitable for families seeking more flexible or diversified investment choices.
Education trusts: An alternative to 529 plans and ESAs is an irrevocable education trust. Although these trusts don’t offer income tax deferral, they can be structured to help beneficiaries qualify for financial aid. This might be more valuable than the tax savings from a 529 plan. Education trusts provide greater flexibility, allowing funds to be used for a wider range of educational purposes, which can include not only traditional college expenses but also trade schools, workshops, community college and private academies. Additionally, trusts can cover alternative education expenses like travel, retreats and business programs, aligning with broader educational values.
Trust creation options: Education trusts can be integrated into your revocable living trust or will, becoming effective upon your death, or established and funded during your lifetime. Disbursements can be directed to specific beneficiaries or a pool of beneficiaries. The trust terms can specify how funds are used, or broad distribution authority can be given to the trustee, with guidelines for distributions provided separately. This flexibility allows for tailored support that aligns with your family’s educational goals.
Tax implications: While education trusts are not primarily tax-saving vehicles, they can still offer tax advantages. If structured correctly, the trust’s income can be taxed at the beneficiary’s rate, which may be lower than your personal rate. Trusts are taxed on undistributed income, but provisions can ensure all income is paid out to beneficiaries, potentially lowering the tax burden. Contributions under the annual gift tax exemption ($18,000 in 2024) do not require a gift-tax return, but exceeding this amount does and reduces your lifetime exemption.
Potential problems: Using retirement funds for education expenses can impact financial aid eligibility. Withdrawals from retirement accounts are considered additional income on the FAFSA, increasing the expected family contribution and potentially reducing financial aid. It’s crucial to consult with a financial advisor to understand the full implications and explore alternative options like 529 plans or education trusts.
Navigating the complexities of saving for education requires professional guidance. An attorney can help you determine the best strategy for allocating resources, whether through a 529 plan, an education trust, or another option.
Send your questions to ccolan@colanlegal.com and use “Alpine Mountaineer estate planning question” as the subject. We’ll answer your questions in our upcoming issues.
This article is provided by your local estate planning attorney, Corina Colan.
The Law Office of Corina I. Colan / (909) 265-3315 / www.colanlegal.com
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