college trust fund vs 529

College Trust Fund vs 529 Plan: How to Choose

College Trust Fund vs 529 Plan: What Parents Need to Know

It’s a privilege to pay for your child’s education, but let’s face it: it’s also a headache. Whether you’re planning to pay the bills as they come in or have been saving since their first birthday, you’ll likely be paying more than just tuition before you see a diploma.

There are many ways to fund a college education, all with different effects on your estate plan—especially if your child decides to switch schools or take a year off. Let’s take a holistic view of paying for your kids’ college without sacrificing your personal assets.

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College Trust Fund vs 529 Plan, ESAs, and Prepaid Tuition

College trust funds, or irrevocable education trusts, hold your child’s school fund in an investment account. This serves a dual purpose: protecting college funds from creditors or misspending, and growing the balance until the money is needed for school.

529 accounts are tax-advantaged savings plans used to pay for a child’s college education. Funds in the 529 plan can be used for qualified education expenses, such as tuition and books, when the child starts college or any other eligible educational institution. In addition, the 2017 Tax Cuts & Jobs Act permit 529 plan funds to be used for public, private, or parochial school tuition for grades kindergarten through 12 (K-12). Not every State recognizes this federal law 

There are two kinds of 529 plans:

  • Prepaid Tuition: Schools and universities across the state offer Florida Prepaid Plans, allowing parents to pay current rates for undergraduate and graduate school tuition. However, students may still have to pay fees for supplies, testing, repeating the same course, or exceeding the maximum hours needed to graduate.
  • Education Savings Accounts (ESAs): ESAs offer an additional savings option alongside 529 plans, with the benefit of providing a financial cushion for unexpected expenses. While ESAs have lower annual contribution limits and restrictions based on income and beneficiary age, they can effectively work together with a 529 plan.

Both education trusts and 529 plans offer considerable tax benefits. In a 529, investment earnings grow tax-free, and education-related withdrawals are tax-free at the federal level. 

However, 529 funds must be spent on certain eligible expenses to maintain tax-free status. If your child uses money from a 529 to move to a new campus, the funds are subject to tax plus a 10% penalty.

Pro Tip 1: Money in 529 accounts created by parents is counted as an asset in FAFSA calculations, but money in 529s created by third parties (such as grandparents) is not. This is something to consider if your child would otherwise qualify for scholarships or financial aid.

Pro Tip 2: Grandparents could seriously supercharge 529 plans for their grandchildren and take advantage of gift tax strategies. Contact us to see if this makes sense for your family.

What Happens to 529 Funds When College Plans Go Awry?

Try as we might, our children don’t always follow the path we set for them. The good news is that if your child has a 529 account, these funds are still available even if they delay college, switch schools, take longer to graduate—or don’t go to college at all.

Here are a few common situations that could affect your 529 funds:

Gap Years

Children are increasingly delaying higher education in favor of traveling the world. Fortunately, a 529 plan can still be used to cover educational expenses once they begin their studies.

  • No Penalty for Delay: There’s no penalty for a gap year; the 529 plan funds do not expire. You can use them if the beneficiary eventually attends an eligible institution.
  • Continue Contributions: You can continue to contribute to the 529 plan during the gap year, as long as you abide by annual contribution limits and other plan rules.
  • Tax Benefits: The tax advantages of the 529 plan remain in effect as long as the funds are used for qualified educational expenses.

Changing Schools

Your child may decide that a different educational institution might better suit their needs. If a child changes schools, a 529 plan remains flexible and can still be used to cover qualified educational expenses. Here’s what you need to know:

  • Use of Funds: You can use 529 plan funds for tuition and other qualified expenses at the new school, as long as it’s an eligible educational institution. This includes colleges, universities, vocational schools, and certain other post-secondary institutions.
  • Transfer of Funds: If the new school has different payment requirements or if you need to change the account setup, you may need to adjust how you withdraw or transfer funds from the 529 plan to pay for the new school’s expenses.
  • No Penalty: Changing schools doesn’t incur penalties or affect the tax benefits of the 529 plan, as long as the funds are used for qualified educational expenses.

Attending College in Another State

Saying goodbye to your child for four years isn’t easy, but you can take comfort in knowing their 529 plan travels with them. Whether the school is in-state, out-of-state, or even in another country (if the institution is eligible), the funds are usable, though state-specific tax benefits might vary. Here’s how it works:

  • Use of Funds: 529 plan funds can be used for educational expenses at any eligible institution, regardless of the state where the school is located. This includes tuition, fees, books, and sometimes room and board if the student is enrolled at least half-time.
  • State Tax Benefits: If you are taking advantage of state-specific tax benefits from your 529 plan like state income tax deductions or credits, you might need to check the rules of your home state. Some states provide tax benefits for contributions to their own state’s 529 plan but not for plans from other states. If you use a 529 plan from another state, you may not receive state tax benefits.
  • Account Management: The account and funds remain the same, so there’s no need to transfer funds to another 529 plan unless you want to switch to a plan in the state where the new school is located. However, this is usually unnecessary and can involve fees or penalties depending on the plan’s rules.
  • Financial Aid: Moving out of Florida could result in your child losing any state-sponsored financial aid, placing a higher burden on the funds in your 529 plan. Check the details of any public or private funding sources so you can plan ahead for additional costs.

Trade School

Many trade schools, also known as vocational or technical schools, are eligible institutions for 529 plan withdrawals. If a child attends a trade school, a 529 plan can still be used to cover certifications and educational expenses. Here’s how it works:

  • Verification: It’s possible to use a 529 for trade school, but the school must be accredited and meet certain criteria to qualify. You should verify the trade school’s eligibility with the 529 plan provider or check the school’s accreditation status.
  • Qualified Expenses: Funds from a 529 plan can be used for educational expenses at a vocational school. However, technical fees and equipment in vocational schools can be considerably more expensive, so make sure the student’s withdrawals are enough to cover additional supplies required for the program.
  • Beneficiary Changes: If the change in schools is accompanied by a change in the child’s educational goals, you may also consider changing the beneficiary of the 529 plan to a different family member.

What Happens to 529 If a Child Does Not Go to College?

Your child’s 529 account is subject to taxation and penalties if your child decides not to go to college. Instead of cashing out the account and taking a significant tax hit, some options to consider include:

  • Change Beneficiary: If the intended child decides not to pursue higher education, you could change the 529 plan’s beneficiary to another qualifying family member. This allows you to use the funds for another family member’s education without incurring penalties, such as siblings, cousins, or even yourself.
  • 529 Into Roth IRA: If the beneficiary is under 30 and the 529 plan has been open for at least 15 years, parents can “roll over” unused funds from 529 college savings plans into a Roth Individual Retirement Account (IRA) in the child’s name. Education funds become retirement funds without incurring penalties or taxes, helping your child in the distant future instead of the near future.
  • Withdraw Funds for Special Circumstances: If you take out funds for non-qualified expenses, you’ll face income tax plus a 10% penalty on the amount. However, if the withdrawal was caused by the beneficiary’s death or disability, or if the qualified expenses exceed the distribution amount, the penalty may not apply.
  • Keep the Funds: There is no expiration date for a 529 plan. You can keep the funds in the account, and they can be used later if the beneficiary decides to pursue higher education or another eligible educational opportunity in the future.

Benefits of College Trust Funds Vs 529 Plans

While 529 plans may be easy to set up, an education trust might be a better choice for some families. It ensures your beneficiaries get the help they need, while giving them the freedom to make the right choices about their future. 

An irrevocable trust offers some significant advantages, including:

  • Customizable Investment Strategies: Trust funds can be tailored to specific investment strategies and goals, providing more control over asset management. In comparison, 529 plans offer limited investment options.
  • Estate Planning Benefits: Since the trust is part of your estate plan, it offers long-term financial benefits while you maintain control over the funds. Trusts manage and distribute assets according to specific terms, which can help prevent misuse of funds.
  • Financial Aid: Money and assets in a trust aren’t counted toward your financial resources, preserving your child’s eligibility for financial aid—something a 529 plan can’t do.
  • Diverse Assets: Trusts can hold a beneficiary’s interest in other family wealth transfer vehicles, such as life insurance.
  • Flexibility: Depending on the trust terms, trust funds can be used for a broader range of purposes beyond education, such as buying a first home.
  • Asset Protection: Funds and assets can remain in the trust long after the student finishes school, protecting wealth from creditors, court judgments, or reckless spending.
  • Professional Management: Trusts can be managed by professional trustees or financial advisors, which can be advantageous if you prefer not to manage the investments yourself.
  • Gift Tax Benefits: Parents may fund a child’s trust up to their annual gift exclusion limit and directly pay educational expenses. Tuition payments do not count against the annual or lifetime gift exclusions, allowing students to have their cake and eat it, too.

In short, 529 plans are advantageous for their tax benefits and specific focus on education savings, but college trust funds offer broader flexibility and customization. The choice between the two will depend on your specific financial goals, needs, and preferences.

Higher Education Means a Review of Your Estate Plan!

Funding isn’t the only consideration for kids headed off to college. Once your child turns 18, you no longer have the same parental right to access their private documents or make life-and-death decisions. There are several vital legal documents college kids must sign before they go off to university, for their own protection and yours.

At Yolofsky Law, we can revise your existing estate plan or create one from scratch that suits your needs now and protects you in the future. Email us at [email protected] today or schedule a 15-minute call to be a hero to your family.