“…for those who are so fortunate as to be burdened with potential estate tax issues, there may be a more advantageous approach that can both fund future educational costs, as well as reduce the donor’s potential future estate tax.”
Many parents like the 529 plan as a great way to fund their children's education. The 529 plans have many attractive features including:
- Tax-free growth of assets;
- Possible tax-deductible contributions at the state level; and
- The ability to change the beneficiary of a plan to another eligible family member, providing the funds are used for education.
A recent article in Forbes, “Funding Education? Consider A Trust Instead of A 529 Plan,” also notes that you can front-load up to five years’ worth of annual exclusion gifts ($14,000/year or $70,000 in total per grantor). However, front-loading the annual exemption doesn’t increase the total exemption available. You’ll exhaust the ability to make annual gifts for that particular beneficiary for the current and next four years. Any contributions to a 529 plan beyond the annual exclusion will impact the donors’ lifetime exclusion, but with a lifetime gift and estate tax exclusion of $5.49 million, it’s not a big concern.
This approach is based on the ability to make certain current gifts, “qualified transfers,” that don’t erode the annual exclusion or lifetime exclusion. Qualified transfers are direct payments for medical and educational expenses.
However, you could use annual exclusion gifts to fund trusts that may be used for education or for other purposes and then directly pay educational expenses as incurred—since the payments don’t count against either the annual or lifetime exclusions. This may work very well for wealthy grandparents. Therefore, annual exclusion gifts that would otherwise have been utilized on 529 plan contributions, can be used to make contributions to an irrevocable trust for the benefit of the child. This means a more efficient, flexible and robust transfer of wealth to the next generation. With this in mind, a trust has some distinct advantages, as far as flexibility, over a 529 plan:
- Trust assets can be designated for a variety of investments, not the limited options of a 529 plan;
- Trust documents can provide the flexibility that lets the trustees distribute assets for education and for other purposes like medical expenses;
- Assets can remain in trust for the benefit of beneficiaries after the education is finished, which offers some asset protection from creditors, divorce, and poor spending habits; and
- A trust can hold life insurance and beneficiary’s interests in other family wealth transfer vehicles.
You should consider the estate tax benefits of using trusts (and paying tuition and other education expenses directly) versus the loss of the income tax benefits of a 529 plan, along with the legal expense of creating a trust. The income tax efficiency of the trust itself also requires planning. Implementing a trust strategy for educational planning and estate and income tax planning is complicated. You need to work with an experienced estate planning attorney.
Reference: Forbes (August 22, 2017) “Funding Education? Consider A Trust Instead of A 529 Plan”