Overview: Trusts versus 529 Plans
Trusts and 529 Plans are both great ways to plan for your children’s, grandchildren’s, or great grandchildren’s future. A trust is more flexible where 529 Plans only allow funding for education. Both have their advantages and disadvantages, but every situation is unique. People should analyze their goals on a case-by-case basis and speak with an attorney and a financial advisor to assist in the decision-making process.
What is a Trust?
A trust is a living breathing legal entity, that can own personal and real property. This means that a trust can own assets during and after one’s lifetime. Trusts are created by settlor(s) who determine how the assets will be distributed to beneficiaries. The settlor(s) can modify beneficiaries and distributions during the settlor’s lifetime. After the settlor(s) pass away it is the trustee’s job to distribute the assets or hold the assets in trust as set forth in the trust language.
Trust Advantages and Disadvantages
Minors in the state of Colorado cannot inherit, so a trust is a way around this dilemma. Trusts allow for a successor trustee to hold funds in trust until the settlor(s) want the money released to an individual above the age of 18. These funds can be distributed as a percentage at a certain age, as one lump sum at a certain age, or many other forms of distribution patterns and restrictions. For example, we typically see settlor(s) leave a 25/30/35 distribution pattern. This means that 1/3 of inheritance is distributed at 25, 1/3 at 30, and the remainder at 35 years old. However, this does not leave the person under the age of 35 without any way to access the trust funds. Typically, a trusts has a Health, Education, Maintenance, and Support (HEMS) standard, which can be accessed by the beneficiary at the trustees discretion. Furthermore, assets can remain in trust for the benefit of beneficiaries even after education is completed, offering a level of asset protection from creditors, divorce, and foolish spending habits. In sum, the advantage of a trust is that a trust allows for more flexibility and more specific distributions then a 529 plan because the funds can be used for other purposes then education.
The main disadvantage with a trust is the tax implications, prices, and financial aid. First, trusts are taxed at the highest income tax bracket, which could be a deterrent for some people. However, there are ways around this, but if you want your assets held in trust then there will be higher tax implications versus giving the money outright to the individual. Second, trusts tend to be more expensive than a will-based plan or a 529 plan because the trust can do more and allows for more specific distributions and flexibility. Third, if a student needs financial aid the trust could be counted in the financial aid process, which could reduce the amount received.
What is a 529 Plan?
A 529 plan is a means of funding someone’s education. A 529 plan is a tax-advantage savings plan designed to help pay for education. 529 plans are named from Section 529 of the Internal Revenue Code. Anyone can open a 529 plan, but typically grandparents and parents open it. The two main types of 529 plans are savings plans and prepaid tuition plans. A savings plan grows tax-deferred, and withdrawals are tax free if used for the qualified education expenses. A prepaid tuition plan allows the owner to pay in advance for tuition at a designated college or university. 529 plans have a series of advantages and disadvantages as defined below.
529 Plan Advantages and Disadvantages
A . Advantages
A 529 plan has a few advantages. Specifically, it is a tax-free growth asset, which allows for tax deduction depending on the state. Generally, a 529 plan allows for clear investments and flexibility in who the beneficiary is. The earnings in a 529 plan are exempt from income taxes if the money is used for qualified education expenses. In addition, there are no limits on how much someone can contribute to a 529 plan each year, but Colorado’s maximum contribution level is $400,000 per beneficiary. Someone also has the option to make a lump sum front end contribution of $75,000 (5-years at $15,000 for each year) to get the immediate benefit of five years’ worth of gift tax exclusions. As a couple, you can double the impact to $150,000 for each and as many Beneficiaries as you have accounts.
Even though there are advantages to 529 plans there are disadvantages as well. First, there is a lack of flexibility with 529 plans. It must be used for education purposes and any other withdraw will be subject to income tax plus an additional 10% penalty, with certain exceptions. Second, investing in a 529 plan will take away from your federal gift tax limit of $15,000 per year. Third, there is a limited choice for investments and the account owner must select from a list of investment options. Fourth, there are fees associated with opening and maintaining the 529 plan. Fifth, the owner of the 529 plan can withdraw the account or change the beneficiary at any time, which can lead to issues if the parents or grandparents were planning on the other funding the individual’s education.
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Trusts and 529 plans are good options in planning for the someone’s future, but both have advantages and disadvantages. It is important to do your own research, meet with an attorney and financial advisor, and create a path that will be best for your future.
If you need guidance with a trust or other estate planning documents Give us a call today (720) 513-2299 or schedule a free initial consultation to learn more about your options.