Saving for College: 529 Plan or Trust?

Phillips (Flip) Ruben, CFP®

Phillips (Flip) Ruben, CFP®

July 6, 2022

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For many parents (and grandparents), investing for college is one of their highest financial priorities. For millions, a 529 College Savings Plan is the backbone of their savings strategy, offering an attractive tax-free route to accumulate funds needed to help pay for qualified higher education expenses, as well as primary education.

Much like Roth IRAs, 529 plans are among a handful of investment vehicles that have the advantages of tax-free growth and tax-free distributions. And their popularity continues to grow: the average 529 plan balance hit a record high of over $28,679 in December 2020, according to the College Savings Plan Network.


Yet a 529 plan may not suit everyone’s needs. Its tax-exempt status comes with certain contribution, distribution and investment choice limitations. Distributions, for example, must be used for qualified educational expenses, or a family may face taxes and penalties. For some families, these limitations may necessitate a different or supplemental path: a more flexible trust, set up with specific needs and objectives in mind.

How important is investment choice flexibility?

529 plans are not brokerage accounts and are limited to the investment choices available on the particular investment platform. These investments consist of a selection of pooled funds, including age-based funds that become more conservative as the beneficiary gets closer to college age. If you intend that to be the only form of investment, a 529 is best suited to your needs.

However, if you intend to include other assets, such as individual stocks and bonds, real estate, or even life insurance, a trust offers more investment flexibility. Trusts may also be structured to allow for greater flexibility in making distributions for purposes other than qualified educational expenses.

How important are gifting contribution limits?

Like most gifting strategies, 529 plans are subject to IRS gift reporting requirements on gifts exceeding $16,000 (2022) per person per recipient. However, each 529 plan contributor can frontload, or superfund, five times the annual gift tax exclusion upfront for the next five years. For a married couple, this can be as much as $160,000.

How important is distribution flexibility?

Saving for College: 529 Plan or Trust?All 529 plan distributions must be used for approved higher educational expenses (college or graduate level) to receive tax-free treatment. There is an exception for up to $10,000 for elementary and secondary school education. Similar to early withdrawals for IRAs, non-qualified distributions are subject to income tax and a 10% penalty on earnings.

Some families can distribute the funds by changing the beneficiary to another “qualified” family member, which is broadly defined, but the distribution restrictions still apply.

On the other hand, when structured appropriately, trusts allow the flexibility to distribute assets for purposes other than educational expenses so long as they are still for the benefit of that individual beneficiary. This may include broad discretion related to health, maintenance and support. If you intend on sending children to private school, a trust may be a good vehicle to direct funding that exceeds the $10,000 limit of 529s.

How do you want to set your kids up for post-college life?

When setting up college funding plans, the post-graduation financial picture shouldn’t be ignored. Consider how much responsibility you want your kids or grandkids to bear when it comes to student loan payments, which are often necessary to supplement college savings. A 529 plan can be used to support some loan payments, meaning that you can make contributions during college not just to pay for tuition but to help ease some of the debt they will face once they graduate.

A trust offers more options for post-college life, however, as it can be set up to support other costs that young adults face when leaving college. They could use those funds to rent their first apartment, where 3-4 months’ worth of rent is often required just to secure the keys, or to furnish their new place. Or, they could simply be distributed to a young graduate as a nest egg for emergencies, giving you peace of mind as they make those first brave steps into the working world.

Financial planning for college should not exist in a vacuum. It should be considered as part of your broader investment and savings plans, ensuring that you are able to grow wealth for your own future while still supporting the future of your children or grandchildren. From the outset, this means considering your cash flow, tax and estate planning objectives.

But it also means considering the next steps for those college savings. Do they get handed over entirely to the graduate, transferred to the next generation, or do you want to transfer what’s left to your broader investment portfolio? While a 529 plan may be more suitable for the former, the latter objectives are better served by a trust.

Education is one of the largest expenses you as a parent (or grandparent) may face. With proper planning, done well in advance of the college years, it is possible to seamlessly transition from financially supporting children to focusing attention on all the other financial priorities in your life.