Saving for college: 529 plan or trust?

By Flip Ruben, CFP

For many parents (and grandparents), investing for college is one of their top financial priorities. For millions of people, a 529 college savings plan is the backbone of their savings strategy, providing an attractive, tax-free path to accumulate the funds needed to help pay for qualified college expenses. , as well as primary education.

Flip Reuben

Like Roth IRAs, 529 plans are among a handful of investment vehicles that offer the benefits of tax-free growth and distributions. And their popularity continues to grow: the average 529 plan balance hit an all-time high of more than $28,679 in December 2020, according to the College Savings Plan Network.

Still, a 529 plan may not meet everyone’s needs. Its tax-exempt status comes with certain restrictions on contribution, distribution and choice of investment. Distributions, for example, must be used for eligible educational expenses, or a family may face taxes and penalties. For some families, these limitations may require a different or complementary journey: a more flexible trust, set up with specific needs and goals in mind.

To determine the right path for college savings, parents and grandparents should start by asking three key questions about their pre-college plan and two about post-college finances.

How important is flexibility in investment choices?

529 plans are not brokerage accounts and are limited to the investment choices available on the particular investment platform. These investments consist of a selection of mutual funds, including age-based funds that become more conservative as the beneficiary approaches college age. If you want this to be the only form of investment, a 529 is best suited for your needs.

However, if you intend to include other assets, such as individual stocks and bonds, real estate, or even life insurance, a trust offers greater investment flexibility. Trusts can also be structured to allow greater flexibility in making distributions for purposes other than eligible educational expenses.

How important are contribution limits?

Like most gifting strategies, 529 plans are subject to IRS gift reporting requirements for gifts exceeding $16,000 (2022) per person per recipient. However, each contributor to the 529 plan can preload, or superfund, five times the annual gift tax exclusion for the next five years. For a married couple, it can go up to $160,000.

Unlike trusts, 529 plans are subject to aggregate contribution limits determined by each state plan. If a grandparent, for example, plans to bequeath a large gift that exceeds the overall contribution limit, a trust may be a preferred fundraising vehicle, perhaps in conjunction with a 529.

How important is distribution flexibility?

All distributions from the 529 plan must be used for approved higher education expenses (college level or higher) to qualify for tax-exempt treatment. There is an exception up to $10,000 for elementary and secondary education. Similar to early withdrawals for IRAs, non-qualified distributions are subject to income tax and a 10% earnings penalty.

Some families can distribute the funds by changing the beneficiary to another “qualified” family member, which is broadly defined, but distribution restrictions still apply.

On the other hand, when structured appropriately, trusts allow the flexibility to distribute assets for purposes other than educational expenses as long as they are still for the benefit of that individual beneficiary. This may include broad discretion related to health, maintenance and support. If you plan to send children to private school, a trust may be a good way to direct funding that exceeds the $10,000 limit of 529s.

Much of college savings planning focuses on the pre-college years, but it’s also important to ask about the post-graduation years to ensure these investments are put in place. to meet your needs. To keep an eye on the future, ask yourself two more questions:

How do you want to prepare your children for post-university life?

When setting up college finance plans, the financial situation after graduation should not be overlooked. Consider how much responsibility you want your children or grandchildren to take on for student loan repayments, which are often necessary to supplement college savings. A 529 plan can be used to support some loan repayments, which means you can make contributions during college to not only pay for tuition, but also to help alleviate some of the debt they will be carrying. faced upon graduation.

However, a trust offers more options for post-college life, as it can be created to support other costs that young adults face when they leave college. They could use these funds to rent their first apartment, where 3-4 months rent is often needed just to secure the keys or to furnish their new place. Or, they could simply be handed out to a fresh graduate as an emergency nest egg, giving you peace of mind as they take their first brave steps into the working world.

Where does the college fund fit into your larger investment plans?

Financial planning for college should not exist in a vacuum. It should be seen as part of your wider investment and savings plans, ensuring that you are able to grow your wealth for your own future while supporting the future of your children or grandchildren. This means considering your cash flow, tax and estate planning goals upfront.

But it also means considering the next steps for these college economies. Are they fully handed over to the graduate, transferred to the next generation, or do you want to transfer what remains to your larger investment portfolio? While a 529 plan may be more appropriate for the former, the latter purposes are best served by a trust.

Education is one of the biggest expenses you can face as a parent (or grandparent). With proper planning, done well in advance of the college years, it is possible to transition smoothly from financially supporting the children to focusing attention on all the other financial priorities in your life.

About the Author: Flip Ruben, CFP®

Phillips (Flip) Ruben, CFP®, is Vice President, Relationship Manager and Financial Planner at Cambridge Trust. With over 20 years of industry experience, Flip provides individuals, families and business owners with expert planning advice for their complex and unique financial situations.

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