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A close family member is about to have a baby, and several family members are looking for a way to allow gifts to contribute to the child's eventual education. The twist is: if the child decides (for whatever reason) that they don't want to go to school, or if they don't need that money for school (e.g. they get a great scholarship) , they can still get access to that money when they reach a certain age.

As an off the cuff example, I would think the money could be used exclusively for education until the child turns 25, at which point the full account would be turned over to them.

The family trusts me to administer the account, but I want to make sure that if something happens to me, the intent of the fund will still be honored. The soon-to-be parents are good people, and I trust them (as people), but they do not have a good track record with handling money.

We are likely not talking about a ton of money going into this account. Probably a max of $1000/year if I had to guess. My (very basic!) understanding of trusts is that they require legal help to set up.

Are 529s and trusts the only option for this kind of thing, or are there other options I should be looking into?

Phil Sandler
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2 Answers2

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The 529 plan does outline your scenarios. There are stipulations for providing the funds should the child get the scholarship. If the child decides not to go into further education (vocational and community schools count), the money can be withdrawn with a 10% penalty and taxes paid on interest earnings. Taxes wouldn't have to be paid for contributions as taxes were already paid on that money by the gift giver. The 529 could also be transferred to another child in the family (including grandchildren).

Here's an excerpt from www.savingforcollege.com:

  1. You'll never lose all of your savings. A 529 plan offers tax-free earnings and tax-free withdrawals as long as the money is used to pay for college. If you end up taking a non-qualified withdrawal, you'll incur income tax as well as a 10% penalty - but only on the earnings portion of the withdrawal. Since your contributions were made with after-tax money, they will never be taxed or penalized.

  2. You can avoid the penalty if you get a scholarship. There are a few special exceptions to the 10% penalty rule, including when the beneficiary becomes incapacitated, attends a U.S. Military Academy or gets a scholarship. In the case of a scholarship, non-qualified withdrawals up to the amount of the tax-free scholarship can be taken out penalty-free, but you'll have to pay income tax on the earnings. As Savingforcollege.com founder Joe Hurley likes to say, "the scholarships have turned your tax-free 529 investment into a tax-deferred 529 investment".

Note, a 529 is ideal for the sum of money you are looking at. A proper trust, set up by a lawyer, will cost as much as $2000 to set up, and would require an annual tax return, both unnecessary burdens. To make matters worse, the trust counts as the child's asset where financial aid is concerned. The 529 counts, but to a much lesser extent.

JoeTaxpayer
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BobbyScon
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There are also low-risk money markets to invest into. With that kind of long-term savings plan I'd look into those first for the investment factor. I used one like this so that I had the flexibility to either use it for a down payment on a house or school. And make sure to name a new administrator in your will if you want to make sure the intent is upheld.

Beth
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