Considering a 529 strategy for certain family trust assets

Considering a 529 strategy for certain family trust assets

Many people establish irrevocable family trusts to fund their children’s college tuition and expenses, but the possibility of higher tax rates in 2013 may make this year an opportune time to consider designating a portion of those trust assets to own a 529 college savings plan.

Irrevocable trusts are generally not tax efficient entities since investment income retained (i.e., not distributed to beneficiaries) is taxed at trust tax rates. There is a wide disparity in income levels between the top tax bracket of a trust compared with that of an individual taxpayer. For example, for tax year 2012, trust income is subject to the maximum 35% tax rate once total income surpasses “only” $11,650. In contrast, individual taxpayers reach the maximum 35% tax bracket once taxable income exceeds $388,350. In addition, the 35% tax rate is scheduled to increase to 39.6% next year if Congress fails to act and the Bush-era tax cuts expire.

One strategy to try to mitigate the tax burden would be to allocate some of the funds from the trust to establish a 529 plan. Clients may want to retain some funds within the trust for other, non-college expenses, which may not be considered qualified distributions by a 529.

The college savings plan would be owned by the trust. The beneficiaries of the 529 and the trust would have to be the same. Investment income would not be subject to the onerous trust tax treatment since 529 assets benefit from tax-free growth and tax-free distribution for qualified expenses.

It’s critical for clients to work with a qualified legal professional since state laws on trusts owning 529 plans may differ. Additionally, some 529 plan providers may have additional requirements or restrictions as well.

More in: College Savings