Irrevocable Trust vs. 529 Plans: Another Approach to Saving for College

Many clients of Dana Whiting Law have financial advisors and CPAs that recommend 529m plans as a tax efficient strategy for saving funds for their children’s education. There is no question that 529 plans can be an important part of any parent’s overall financial plan. This purpose of this article is to highlight an alternative strategy that can be implemented as part of your entire estate plan, not just college savings.

There are many articles a click away that explain the ins and outs of 529 plans. For purposes of this article, suffice it to say that a 529 plan is a special type of savings account that gets special treatment from the Internal Revenue Code. To put it simply, a gift to such an account will grow tax free and can eventually be withdrawn by the beneficiary tax free to the extent that the distributions are used for qualified educational expenses.

To sweeten the deal, the code further allows the person making the gift to front load the account with five years of gifting. For example, this year the annual exclusion amount is $18,000. That means you can make a gift of up to $18,000 to any one donee without being required to report the gift on a tax return or using any of your lifetime gift tax exemption. However, for gifts to a 529 plan you can make a gift of $90,000 in a single tax year without using your exemption.

However, it may be surprising to learn that there may be an even better way to help you save money for your children in a tax-efficient way. Furthermore, it’s a strategy that has already been commonly used by many people as part of their estate plan. This strategy is simply making a gift to an irrevocable trust for the benefit of your child or children. The purpose of this article is to highlight the advantages of this strategy when compared to 529 plans, as well as to acknowledge some disadvantages.

The most important advantage of an irrevocable trust is the control you have as the person creating the trust. You get to set the rules for the trustee over the trust with respect to how the assets of the trust are managed and eventually distributed. You can specify conditions for making distributions like when the beneficiary reaches certain milestones or ages. And what if there are still funds when the beneficiary has completed his or her education? With a trust, the funds are not limited to educational use. For example, you can design the trust so that the funds could be used for starting a business or purchasing a home.

Furthermore, depending on various factors that vary state to state, assets held in an irrevocable trust that is not self-settled (the beneficiary didn’t create the trust for himself or herself), assets held in an irrevocable trust may be better protected from claims by creditors, ex-spouses, bankruptcy trustees, and lawsuits compared.

As discussed in various other articles on this website, an irrevocable trust can be structured in such a way as to minimize exposure to both the estate tax and income tax liability.

Despite these advantages, it is important to note that establishing an irrevocable trust, not to mention the ongoing maintenance, can be more complicated and therefor more expensive than contributing to a 529 plan.

Importantly, the objective addressed in this article is college savings. As discussed above, a 529 plan offers income tax advantages specifically for qualified education expenses. No matter how attractive the advantages of the trust strategy are, there may not be a way to match the tax free growth of a 529 plan.

In sum, the flexibility and control that is possible when gifting to an irrevocable trust may be more valuable to some savers than the special tax treatment of a 529 plan. The estate planning attorneys of Dana Whiting Law can be an important part of your advisory team when evaluating these options.