Saving for College in Trust Accounts: Getting the Definitive Word on Trusts

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If you're like most people, you may immediately associate the word trusts with a picture of great wealth and privilege. After all, the only people who set up trusts are those who can afford to fund them, and the only people who have trust funds set up for them do things like play polo and wear blazers with little crests on the pockets. Right?

Wrong. Trusts come in all sizes and shapes, and they may serve your needs. Because of their amazing flexibility, the protections they offer you and your family, and the fact that you determine how the trust will operate, saving for all or a part of future college expenses inside of a trust may suit you better than relying totally on other forms of college saving, including a Section 529 plan or a Coverdell Education Savings Account (ESA). You may also discover that augmenting other savings you have with those in a trust gives you the control and the safeguards you're looking for.

In this article, you find out what trusts are and what they can do for you. You see how they can provide you with the assurance that the money you save today will be used only for purposes that you approve of down the road.

Getting The Definitive Word On Trusts

A trust is a legal entity that is able to hold assets of one person for the benefit of any other person or people (including the person whose assets the trust holds).

You may put as much money into a trust as you want, know that the money is always invested, and then have the trustee make distributions when the time comes for whatever expenses, educational or otherwise, you want. You have no limitations on contributions if you make over a certain amount of money, and no restrictions (other than the ones you impose) on the size of the distributions when they are made. None of the rules that govern what expenses you may pay using tax-free or tax-deferred distributions from Section 529 plans, Coverdell Education Savings Accounts, or Series EE or Series I savings bonds apply to trusts. Depending on the rules contained in the trust instrument (which you create when you create the trust), the trustee may make distributions to the beneficiary, or on the beneficiary's behalf, to pay for any of that beneficiary's expenses, whether directly for educational expenses or for any other purpose.

In exchange for the freedom a trust offers, you pay a price. The income earned inside a trust is taxed in the year in which it is earned; there are no deferrals.

When you hear people talking about trusts, they generally throw around a lot of terms that sound impressive but that really only define clear roles and relationships within this legal entity. Here are a few of those terms:

• The grantor (or the donor): This person (or people) actually creates and funds a trust.
• The beneficiary: This is the person (or other being) who is entitled to receive payments from the trust. You're not at all limited here. When you create a trust instrument, you must define who the beneficiary is (either by name or by class of people, such as your children or your grandchildren), as well as a whole slew of contingencies if that beneficiary can't or doesn't use up all the money. Your contingent beneficiaries, however, don't have to be related to the original beneficiary in any way. Not only do you not need to name specific names, but beneficiaries (and contingent beneficiaries) don't even need to be alive yet when you set up your trust. You choose.
• The trustee (or fiduciary): This person or institution (accountants, attorneys, banks, and trust companies are very popular choices here) is responsible for the assets in the trust and for making sure that the assets are used in the manner you indicate when you set up the trust.
• The trust instrument: This legal document governs how your trust works. Have an attorney who is very knowledgeable about trusts and how they function draft this document for you, and be certain you understand its provisions before you sign it.

No two trusts are identical, and there is no one, perfect trust that will solve everyone's needs. When creating your trust, be as specific as you can about what you're trying to achieve. Only then will the attorney drafting your trust instrument be certain to include all the provisions you feel are important.