How to Plan for Your Child’s College Education Using Trusts

The aspiration to provide a college education for a child or grandchild is a cornerstone of family legacy planning for many Maryland residents. As the costs of higher education continue to rise, proactive financial planning becomes not just beneficial but essential. While various savings vehicles exist, establishing a trust offers a powerful and flexible strategy to manage, protect, and distribute funds designated for educational pursuits.

Differentiating Trusts from Other College Savings Methods

Many families in Maryland are familiar with 529 plans, which are popular, tax-advantaged savings plans designed specifically for education expenses. The state offers both the Maryland College Investment Plan and the formerly available Maryland Prepaid College Trust. These plans provide notable benefits, including state tax deductions on contributions and tax-free growth when funds are used for qualified education expenses. However, they are not without their limitations.

A trust operates under a different legal framework. It is a fiduciary arrangement where you, the grantor, transfer assets to a trustee. This trustee has a legal duty to manage these assets for the benefit of a third party—in this case, your child or grandchild, the beneficiary. Unlike a 529 plan, which is primarily an investment account with specific rules, a trust is a highly customizable legal document.

This distinction is meaningful. A trust can be crafted to your precise specifications, providing a level of control that extends far beyond what a 529 plan allows. While a 529 must be used for qualified educational expenses to receive favorable tax treatment, a trust can be designed to cover a broader range of life expenses, offering a safety net for the beneficiary beyond just tuition and books.

The Mechanics of an Educational Trust

Creating a trust for educational funding involves several key steps. The process begins with drafting a legal document that outlines the rules of the trust. This document will name the trustee—the person or institution responsible for managing the trust’s assets—and the beneficiary. It will also contain your specific instructions for how the funds are to be distributed.

Funding the trust is the next step. This involves transferring assets, which can include cash, securities, real estate, or other property, into the name of the trust. Once funded, the assets are legally owned by the trust, not by you or the beneficiary directly. This legal separation is what provides many of the protective benefits associated with trusts.

The instructions you provide in the trust document are paramount. You can dictate the precise circumstances under which the beneficiary can receive funds. For example, you might stipulate that distributions are to be made directly to the educational institution for tuition. You could also allow for funds to be used for room and board, study abroad programs, or even for non-educational milestones, such as a down payment on a first home, after graduation. This level of customization ensures your legacy is managed according to your values and goals.

Types of Trusts Suitable for Education Planning

Maryland law accommodates several types of trusts, each with features that can be advantageous for college planning. The choice between them depends on your specific financial situation, your goals for the assets, and your desired level of control.

• Revocable Living Trust: This type of trust is created during your lifetime and can be amended or revoked at any time. You can act as the initial trustee, maintaining full control over the assets. Upon your passing or incapacitation, a successor trustee you’ve named takes over. While a revocable trust offers flexibility, the assets within it are still considered part of your estate for tax purposes and are generally not protected from your creditors.
• Irrevocable Trust: Once an irrevocable trust is established and funded, it generally cannot be changed. By transferring assets into an irrevocable trust, you remove them from your personal estate. This can offer significant benefits, such as reducing potential estate taxes and providing robust protection from creditors. Because the assets are no longer legally yours, they are shielded from your personal liabilities.
• 2503(c) Minor’s Trust: Named after a section of the Internal Revenue Code, this is an irrevocable trust designed specifically for a single minor beneficiary. Gifts made to a 2503(c) trust can qualify for the annual gift tax exclusion. The trustee can use the funds for the child’s benefit, and any remaining assets must be made available to the beneficiary when they turn 21. This structure provides a clear timeline and purpose, making it a popular choice for education funding.
• Crummey Trust: This is another form of irrevocable trust that allows your contributions to qualify for the annual gift tax exclusion. It achieves this by giving the beneficiary a temporary window of time (often 30 days) to withdraw any new contribution made to the trust. If the withdrawal right is not exercised, the funds remain in the trust to be managed according to its long-term provisions. This feature makes it a flexible tool for funding a trust over many years while minimizing gift tax implications.

Key Advantages of Using a Trust for College Savings

Choosing a trust over or in addition to other savings methods provides a distinct set of advantages that can be tailored to your family’s needs.

• Control Over Asset Distribution: A trust allows you to set detailed conditions for how and when the beneficiary receives the funds. You can ensure the money is used specifically for education or tie distributions to certain achievements, like maintaining a specific grade point average. This prevents a young adult from receiving a large lump sum of money before they are mature enough to handle it responsibly.
• Protection from Creditors and Legal Claims: Because the assets in an irrevocable trust are legally owned by the trust itself, they are generally shielded from the creditors of both the grantor and the beneficiary. If you or your child were to face a lawsuit or bankruptcy, the funds dedicated to their education would likely remain secure.
• Flexibility Beyond Qualified Education Expenses: Life is unpredictable. A trust can be drafted to permit distributions for a wide array of needs beyond what a 529 plan covers. This could include medical emergencies, living expenses, or seed money for a business venture after graduation. This provides a more holistic form of support for your loved one.
• Planning for Multiple Generations: Some trusts, known as generation-skipping trusts, can be structured to provide for grandchildren and even great-grandchildren. This allows you to create a lasting educational legacy that can benefit your family for decades to come.
• Management During Incapacity: A trust provides a clear succession of management. If you, as the initial trustee of a revocable trust, become incapacitated, your chosen successor trustee can immediately step in to manage the assets and ensure the beneficiary’s educational funding continues without interruption or the need for court intervention.

Tax Considerations for Educational Trusts in Maryland

The tax implications of an educational trust are a significant factor in the planning process. While trusts do not offer the same state income tax deductions as Maryland’s 529 plans, they have other tax attributes to consider.

Contributions to an irrevocable trust are considered gifts. Under federal law, you can gift up to the annual gift tax exclusion amount to any number of individuals each year without incurring gift tax or having to file a gift tax return. For irrevocable trusts like a 2503(c) or Crummey trust, contributions are structured to qualify for this annual exclusion. This allows you to fund the trust over time in a tax-efficient manner.

From an income tax perspective, the trust is a separate taxable entity. Income generated by the trust’s investments (such as interest, dividends, and capital gains) is taxed to the trust itself. However, when income is distributed to the beneficiary, it is typically taxed at the beneficiary’s income tax rate, which is often lower than the trust’s compressed tax brackets. A knowledgeable attorney can structure the trust to manage these tax liabilities effectively.

Furthermore, for families with substantial assets, placing funds in an irrevocable trust can remove those assets from their taxable estate, potentially reducing or eliminating federal or Maryland estate taxes upon their death.

The Impact of a Trust on Financial Aid Eligibility

A common question is how holding assets in a trust affects a student’s ability to qualify for financial aid. The answer depends on the type of trust and how it is structured. The Free Application for Federal Student Aid (FAFSA) has specific rules for reporting trust assets.

For a revocable living trust, the assets are still considered to belong to the grantor. If the grantor is the parent, the assets are reported on the FAFSA as a parental asset. Parental assets are assessed at a lower rate than student assets, having a smaller impact on the expected family contribution.

Assets held in an irrevocable trust may be treated differently. If the trust document requires that the funds must be used for the beneficiary’s education, it may be considered an asset of the student. However, if the trustee has discretion and is not required to make distributions, the trust’s value may not need to be reported as an asset on the FAFSA at all.

Distributions from a trust made directly to the student are often counted as untaxed student income, which can significantly reduce financial aid eligibility in a subsequent year. Careful planning is needed to structure distributions in a way that minimizes this negative impact. An estate planning attorney can provide guidance on drafting the trust and timing distributions to work in concert with your financial aid strategy.

Integrating a Trust with Your Overall Estate Plan

An educational trust should not be created in a vacuum. It is a component of a comprehensive estate plan that includes other vital documents like a Last Will and Testament, Powers of Attorney, and healthcare directives. These documents work together to ensure all of your wishes are carried out and your loved ones are protected.

Your will can include provisions that pour any remaining assets from your estate into the educational trust, a strategy known as a testamentary trust. This ensures that even assets not initially placed in the trust can ultimately be used for your child’s educational benefit.

By coordinating your educational funding strategy with your broader estate plan, you create a cohesive and resilient plan that can adapt to changing circumstances while steadfastly protecting your goals for your family’s future.

Contact Our Experienced Maryland Estate Planning Lawyers Today

Providing for a child’s higher education is one of the most meaningful gifts you can give. The complexities of rising tuition costs and intricate financial aid rules require a sophisticated and forward-thinking approach. Using a trust as part of your college savings strategy offers unparalleled control, protection, and flexibility, ensuring your legacy of support endures.

If you are a Maryland resident considering how to best plan for a child’s or grandchild’s educational future, taking proactive steps is essential. We invite you to contact Baddour Law Firm to schedule a consultation. Let us help you navigate the options and implement a comprehensive estate plan that secures your assets and fulfills your family’s aspirations.