There are some overlooked ways of paying for college. One such overlooked funding idea is the topic of this blog.
Often families choose tax-free 529 plans. The reasons are plenty. 529 plans are a fabulous way to pay for college due to their tax free structure and high dollar number. Note, however, that you fund it with after tax dollars, but the growth and withdrawal is tax free. We can summarize some key advantages of 529 plans as:
A big disadvantage of a 529 plan is that investment options in 529 plans are limited to mutual funds or preset portfolios that are designed to get more conservative as a college admissions date nears. If you use assets in your plan for expenses that aren’t education-related, you face paying taxes and a 10% penalty on earnings. So if you overfund it and are unable to transfer it to other family members for educational purposes, you are faced with paying taxes and a penalty.
An important overlooked way of funding college education is a trust--and many families are choosing a trust due to its flexibility. While a 529 plan limits how much you can invest, where you can invest, and how the assets must be used, a trust is more of a blank slate or a canvas that can be structured, funded, and invested however you like.
There are however good reasons to use 529 plans and trusts simultaneously, to get the best of both, financial advisors say.
How it works
A trust can be much broader in scope than a 529 plan, and there are no limits on how much you can put away.
“Your trust can just be for education costs, or it can also be for other purposes, like to start a business or purchase a home,” says Jeanne Sun, head of the advice lab at J.P. Morgan Private Bank.
While assets in trusts can’t be withdrawn tax-free, there are no limits on how they can be invested, creating the potential for higher returns. A trust fund can ensure that the grantor’s wishes are carried out, which can be useful if the grantor is concerned about whether the beneficiaries can make wise decisions. For example, a trust fund can prevent a child from spending his or her college savings on a sports car or a vacation.
Consequently, annual exclusion gifts that otherwise would have been utilized on 529 plan contributions can be used to make contributions to an irrevocable trust for the benefit of the child, resulting in a more efficient, flexible and robust transfer of wealth to the next generation.
J.P. Morgan’s Sun often recommends that clients use both 529 plans and a trust. The idea is to fund the 529 plans conservatively so they are no unused assets subject to taxes and penalty, while the trust can pick up education costs where the 529 plans fall short. That way, you get some tax-free investing, and the flexibility and benefits that come with a trust.