For many people, leaving a legacy for their children, grandchildren, and future generations is an important goal of the estate plan. Providing for their educational needs is a great way to ensure financial security for their future. A 529 plan can be a highly effective tool for funding tuition and other educational expenses on a tax-advantaged basis. “When the 529 plan’s owner, which is typically a parent or grandparent, passes away, there’s no guarantee that subsequent owners will continue to use it to fulfill the original owner’s vision,” explains Principal Dan Ruttenberg.
A carefully designed trust may be the best solution to create a family education fund that lives on for generations. But education trusts can also have significant drawbacks. Principal Jason Smolen adds, “Unlike 529 plans where the earnings are tax-exempt if used for qualified education expenses, education trusts are subject to some of the highest federal income tax rates in the tax code.”
One strategy for gaining the best of both worlds is to establish a family education trust that invests in one or more 529 plans.
Plan basics
529 plans are state-sponsored investment accounts that permit parents, grandparents and other family members to make substantial cash contributions. Contributions are nondeductible, but the funds grow tax-free and earnings may be withdrawn tax-free for federal income tax purposes, provided they’re used for qualified education expenses. Qualified expenses include tuition, fees, books, supplies, equipment, and some room and board at most accredited colleges and universities as well as certain vocational schools. Contributions to 529 plans are removed from your taxable estate and shielded from gift taxes by your lifetime gift and estate tax exemption or by annual exclusions.
In addition to the risk that a subsequent owner will use the funds for non-educational purposes, the disadvantages of 529 plans include relatively limited investment choices and an inability to invest assets other than cash.
Holding a 529 plan in a trust
Establishing a trust to hold one or more 529 plans provides several significant benefits:
- It allows you to maintain tax-advantaged education funds indefinitely (depending on applicable state law) to benefit future generations and keeps the funds out of the hands of those who would use them for other purposes.
- It allows you to establish guidelines on which family members are eligible for educational assistance, direct how the funds will be used or distributed in the event they’re no longer needed for educational purposes, and appoint trustees and successor trustees to oversee the trust.
- It can accept non-cash contributions and hold a variety of investments and assets outside 529 plans.
A trust may also use funds held outside of 529 plans for purposes other than education, such as paying medical expenses or nonqualified living expenses.
Plan carefully
If you’re interested in setting up a family education trust to hold 529 plans and other investments, contact Jason Smolen or Daniel Ruttenberg. We can help you design a trust that maximizes educational benefits, minimizes taxes and offers the flexibility you need to shape your educational legacy.
About the Authors
Jason Smolen
Jason Smolen is a founding principal of SmolenPlevy. Smolen’s knowledge of complex estate and business issues has drawn the attention of ABC News, USA Today, E! Online, Realty Times and the Bank of America Small Business Online Community. Mr. Smolen is a graduate of the City College of the City University of New York and the George Mason University School of Law. Smolen also serves as a board member of a local citizens association and recently co-authored an article titled Why You Should Think About Spousal Limited Access Trusts (SLATS).
Daniel H. Ruttenberg
Daniel H. Ruttenberg, JD, CPA, LLM is a principal with the firm. Mr. Ruttenberg received his Bachelor of Science degree with a double major in Accounting and Finance from the University of Maryland. He earned his Juris Doctor with Honors from George Mason University School of Law and his Master of Laws in Taxation with Distinction from Georgetown University Law Center. Mr. Ruttenberg also served as the Director of the Fairfax Bar Association (FBA) for seven years. During this period, he was also elected president – the youngest in FBA history and served as a member of the Board of Directors for the Fairfax Law Foundation.
