Leaving money for college: Education trusts

The cost of raising a child is constantly escalating, and it is predicted that raising a child through age 17 will cost parents $286,000. Education is one of the expenses that has seen the largest increase, making saving for your child's education a must.

There are many different options for a parent to invest money now so that his or her child will have a secure educational future. One option is setting up an education trust fund.

What is a trust?

A trust is a legal arrangement in which property is given by a grantor and is held by an appointed trustee for the benefit of someone else, known as the beneficiary of the trust. The trustee manages the trust and the beneficiary receives the property within the trust. 

Trust funds are becoming common amongst parents who would like to make sure their children are well taken care of after the parents have passed, establish financial security, minimize death taxes and preserve their own capital. One option for parents is setting up an education trust fund.

Advantages of a trust

There are many benefits to establishing a trust; once the trust transfers ownership from the grantor to the beneficiary, the property is no longer included in the grantor's taxable estate. In addition to the tax benefits that often come with establishing a trust, anyone can set up a trust for any child and the contribution amount per year is unlimited. 

The main advantage of establishing an education trust is control; a trustee is appointed by you, the grantor, allowing you to ensure that there is no risk of your child obtaining the rights to the assets before they are of a responsible age. This ensures that if the child is a minor, the trust will control the assets until the child is a responsible adult, as it limits the child's access until he or she reaches a specific age. Therefore, when an educational trust fund is set up by parents for their children, the money should be handled by a trustee who can be responsible for managing the money. This ensures that the child, as the beneficiary, cannot recklessly spend the money that has been set aside for his or her education.

In addition, the assets in the trust do not become part of the grantor's estate, reducing fees paid on assets and death tax responsibilities after one's death. Peace of mind also comes with establishing a trust; your trust will ensure that your specific wishes are carried out. Finally, anyone can establish an education trust, whether it is a parent, grandparent, aunt, uncle, or anyone else who holds an interest in the child's education.

Preserving your child's education

An education trust allows you to gift property to your child to be used for education purposes.  This is a very flexible way to invest in your child's education, as you can set up a trust using property or funds to benefit your child in the future.

There are two types of trusts a parent (or other benefactor) can set up: a living trust is created during the lifetime of the grantor, while a testamentary trust is established by a provision in a will. Either one can be used to fund a child's education. For example, a testamentary trust can be established by a last will upon the benefactor's death and could then be used to provide funds specifically for a child's education. 

A living trust is another option in which a grantor can provide money for a child's education. Living trusts can also help avoid probate, saving time and money. And because the trust document is ordinarily not made public, it provides confidentiality to the grantor.

When should I consider an education trust?

Because a trust should be established using an outside advisor, a trust should usually be considered if the amount of money you are setting aside for your child is a substantial amount, such as more than $100,000; smaller amounts can be invested in an education savings plan, such as a 529 plan.

Your trust must specify how the assets are managed, so be sure you designate a reliable person to act as the trustee. Because this is an education trust, a clause should instruct how the trust funds are to be used in the event that the child does not go on to pursue higher education.

What next?

Explore your options. You can specify ages or achievements as the terms of disbursement and you can choose to have the money parceled out over time or delivered in one lump sum. Your decisions will be different depending on what are you trying to accomplish with the trust: Do you want to make a certain amount available each year to pay for an education or do you want your beneficiary to receive all the money upon completion of an education? Also, be sure to speak with a tax professional so you understand how the contributions and dividends will be taxed.