Many parents are concerned about how they will pay for their children’s college expenses. With an eye to the future, parents can set up trust funds for their children, or grandparents can establish trusts for grandchildren. Setting up a trust protects assets for the beneficiary -- in this case, a child. While the child is a minor, a trustee handles the trust so the child can’t fritter away the money. The grantor -- the person who sets up the trust -- also can benefit by saving on estate tax as well as income and gift taxes.
Choosing a Trust
Faced with a confusing array of types of trusts, prospective grantors should consult an attorney for advice on which type best carries out the grantor’s intentions as well as providing the best tax advantages. An irrevocable children’s trust -- a Section 2503 Minor's Trust -- isn’t part of the contributor’s taxable estate, and creditors can’t seize property in the trust. Avoiding the annual gift tax is one advantage of creating a trust for a minor. While setting up a trust for a child doesn’t automatically qualify for the annual gift tax exclusion, two types of trusts do qualify for that exclusion: the Section 2503(b) and Section 2503(c) trusts. They are named for the Internal Revenue Code provision in which they were created.
Section 2503(b) Trust
This type of trust requires that income must be distributed to the child at least once a year. If the child is still very young, the income can be transferred to a custodial bank account. The child could also be allowed to withdraw a sum equal to the annual gift tax exclusion. The child’s parent decides whether the child should be allowed to make this withdrawal. This type of trust doesn't require access at the age of 21, and the principal can continue to be held in the trust as long as the parents wish.
Section 2503(c) Trust
A Section 2503(c) trust allows all the principal and income to be used for the child until he reaches the age of 21, unlike the 2503(b) trust that extends beyond age 21 and requires income to be paid to the child annually. The trustee can pay the child’s college expenses from the 2503(c) trust. When the child turns 21, all the money remaining in the trust must be turned over to him, unless he decides to extend the trust. Before choosing this trust, the grantor should consider whether the child would be mature enough at 21 to handle the money responsibly.
A testamentary trust could be appropriate for grandparents as well as parents because it is part of the grantor’s will. It takes effect after the grantor dies and specifies the amount of money to be included. The testamentary trust takes the place of specific bequests and defines how the money must be used -- specifically for education, for example.
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