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Should You Use a 529 Plan or a Trust to Save Money for College?

December 14, 2022

Escalating college costs mean that many families are trying to find the most cost-effective way to put away money for their kids. If you want to set aside a significant amount of money for your children’s or grandchildren’s college education, the two most common options are 529 plans and trust funds. A 529 plan is a tax-advantaged savings plan designed to help families save for future education costs. Which option is best depends on several factors discussed below. 

Income Tax Deferral and Exemption

A key benefit of 529 plans is that the money grows tax-free until it is withdrawn. Further, so long as the funds are used for qualified educational expenses, none of the money will be taxed after it is taken out. In contrast, money invested in a trust fund will result in taxable income to the trust or the grantor every year.

State Income Tax Deduction

In some states, contributions to a state-sponsored 529 plan will trigger a potential state income tax deduction subject to a cap (e.g., $10,000 for married taxpayers filing jointly). Contributions to trusts will not receive such deductions.

Contribution Limits

State-sponsored 529 plans usually have a limit on the total amount that may be contributed (e.g., $300,000). However, there are ways to get around the limit, such as by setting up accounts with other state-sponsored 529 plans or with private 529 plans offered by financial institutions. There is no contribution limit for a trust fund.

Financial Aid Impact

Funds invested in both 529 plans and trusts have to be disclosed on FAFSA applications. However, generally, trust funds will reduce eligibility to a much greater degree than 529 plan balances.

Overhead and Administration

Trusts can have significant costs associated with setting them up and ongoing administration depending on the size and complexity of the trust and may be required to file annual tax returns. In contrast, state-sponsored 529 plans typically have very low overhead. Often, fees are less than 1% of the funds under management. They also do not require any separate tax returns. 

Flexibility in Changing Beneficiaries

A common concern of families saving money in either a 529 plan or a trust is what happens if their child doesn’t go to college or doesn’t need all of the money for college. 529 plan funds can be used for vocational and trade schools and apprenticeships, as well as elementary and secondary schools, within certain limits. In addition, 529 plans allow the account owner to change the beneficiary of the account provided that the new beneficiary is related to the prior beneficiary within certain categories (e.g., spouse, child, sibling, cousin, niece/nephew or aunt/uncle). However, trusts are usually irrevocable and typically do not permit beneficiaries to be changed after the trust is created.

529 Plans vs Trust Funds

College expenses can be a significant burden so it’s important to understand when and how you can reduce your cost through tax deductions and lower fees. However, what works for one family may not work for another, so it is best to get professional advice. Before you make a decision, you should also have a broader conversation about financial and tax planning with your advisors. We analyze our client’s needs and goals and help them take advantage of every opportunity to save money and maximize their income. Contact us today to develop a financial plan that incorporates paying for college.


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