Am I Saving for My Kid’s Future the Right Way?

Jun 23, 2023

The Definitive Explanation of 529 Plans vs Trusts

If you’re thinking about saving for your child’s future, you’ve already taken a huge step. As a parent, you want to provide the best opportunities for your child's future, and that often includes saving money for their education or other life milestones. Two popular options for long-term savings are 529 plans and trusts. In this blog post, we'll explore what these options are, how they work, and the pros and cons of each, helping you make an informed decision when it comes to securing your child's financial future.


529 Plans: Saving for Education

A 529 plan – so named because of the section of the Internal Revenue Code that controls it – is a tax-advantaged savings plan. They are typically opened by parents, grandparents, or guardians and are specifically designed to offset educational expenses for the beneficiaries. A 529 plan is not unlike a 401k plan in that you’re funneling money into an investment portfolio with the goal of building a robust savings account based on your contributions and the earnings from those investments. The earnings grow tax-free and withdrawals are tax-exempt, provided they’re used for qualified expenses.

Pros and cons of 529 plans

Each state manages its own 529 plan. Typically, you’ll want to open a plan in your home state – although it’s important to look at all aspects of the plan before making your decision.1 Plans sometimes include account opening fees, annual fees, or account management fees so look at a few plan options before making your choice.

The plan will need to have a named beneficiary. This is the person for whom you’re saving money, and it doesn’t have to be a child. Beneficiaries must be a US citizen or resident alien and have a social security number. With a 529 plan, you can change the beneficiary with no penalty.

It can be overwhelming to interpret plan performance and fees. Consider a financial advisor to help navigate your choices. Most financial institutions will have advisors that can help. When you’re ready to open the plan, it’s typically a simple online process. You’ll need to provide at least your social security number, your address, and your date of birth. This same information will need to be provided for the beneficiary as well.

Once you’ve selected your beneficiary and plan, you choose your investments. Most plans offer an aged-based option, meaning your investment allocations change as the beneficiary ages. As the beneficiary gets older and closer to tapping into the funds, the investment allocation will adjust to be more stable.

Pros + Cons of 529 Plans


Here are the Pros of 529 Plans:

  1. Tax advantages, both for growth and withdrawals: One of the significant benefits of 529 plans is the tax advantages they offer. Contributions to a 529 plan grow tax-free, meaning you won't have to pay federal taxes on the investment gains. This tax-free growth can significantly boost the overall value of the account over time. Furthermore, withdrawals made for qualified educational expenses are also tax-free at the federal level. This allows you to maximize the funds available for your child's education.

New York’s 529 plan allows for contributions up to $17,000 per year ($34,000 if married filing jointly) without triggering federal gift taxes.2

  1. Flexibility in choosing beneficiaries: 529 plans provide flexibility when it comes to choosing beneficiaries. While the initial intention is typically to save for your child's education, if your child decides not to pursue higher education, you have the option to change the beneficiary. You can transfer the funds to another family member, such as a sibling or a cousin, who can benefit from the educational savings. This flexibility ensures that the funds won't go to waste even if your child's plans change.

The funds in a 529 plan can be rolled over into a Roth IRA with no taxes or penalties, as long as the plan has been opened at least 15 years. Other limitations apply.

  1. High contribution limits: 529 plans often have high contribution limits, allowing you to save a substantial amount of money for education. The limits vary by state and plan, but they can be as high as several hundred thousand dollars per beneficiary. This high ceiling gives you the opportunity to accumulate a significant sum over time, ensuring that your child has the financial resources needed to pursue their educational goals.

  2. Potential state tax benefits: In addition to the federal tax advantages, many states offer their own tax benefits for 529 plan contributions. This can include deductions or credits on state income taxes for contributions made to a 529 plan. The specific tax benefits vary by state, so it's important to consult your state's tax regulations or speak with a tax professional to understand the potential savings available in your particular situation.

What expenses are considered "qualified" in a 529 plan

  1. Can be used for various qualified educational expenses: 529 plans can be used for a wide range of qualified educational expenses. While they are primarily associated with college or university expenses, funds from a 529 plan can also be used for tuition at elementary and secondary schools. Additionally, certain expenses such as books, supplies, and room and board can be covered. This flexibility allows you to use the funds for various educational needs, ensuring that your child's education-related expenses are adequately supported.

And Here Are the Cons of 529 Plans

  1. Limited to education expenses: One of the main drawbacks of 529 plans is their restriction to qualified educational expenses. While this limitation aligns with the primary purpose of these plans, it can become a disadvantage if your child decides not to pursue higher education or if they receive scholarships that cover most of their educational costs. In such cases, using the funds for non-qualified expenses may result in taxes on the earnings plus a 10% penalty.

You'll have to report your 529 plan spending to the IRS, so keeping careful records is important.3

  1. Penalties for non-educational withdrawals: If you withdraw funds from a 529 plan for non-qualified expenses, such as a vacation or a car purchase, you will face penalties. In addition to the tax on the earnings, you will be subject to a 10% penalty. This penalty can significantly reduce the overall value of the account and diminish the intended benefits of the 529 plan.

  2. Potential impact on financial aid eligibility: The assets held in a parent-owned 529 plan are generally considered parental assets on the Free Application for Federal Student Aid (FAFSA). This means that a portion of the assets may be factored into the calculation of the Expected Family Contribution (EFC), potentially reducing the amount of need-based financial aid your child may receive. Plan ownership can determine how much impact it has. For example, if grandparents own the plan, the balance could reduce financial aid eligibility by as much as 50%.1 It's important to understand how 529 plans can affect financial aid eligibility and consider this aspect when making decisions about saving for education.

  3. Limited investment options: While 529 plans offer investment options, they are typically limited to a selection of pre-determined portfolios. These portfolios are managed by the plan provider and may not align with your specific investment preferences or risk tolerance. The lack of flexibility in choosing individual stocks, bonds, or other investment vehicles can be a disadvantage for those who prefer a more hands-on approach to investing or have specific investment strategies in mind.

What expenses are not considered "qualified" in a 529 plan

  1. Potential fees and expenses: 529 plans may involve fees and expenses, which can vary depending on the plan provider and investment options chosen. Common fees include enrollment fees, administrative fees, and investment management fees. These costs can eat into the overall returns of the account and reduce the amount available for educational expenses. It's crucial to understand the fee structure of the specific 529 plan you are considering and factor in these expenses when evaluating the potential benefits.

Are Trusts a Viable Option for Educational Expenses?

There’s a long-standing belief that trusts are a savings tool used exclusively by the wealthy. But the fact is a trust is simply a legal arrangement where a trustee (you) holds and manages money for the benefit of the trust's beneficiaries (your child). When the beneficiary reaches a certain age, the money becomes available to them. Trusts offer more flexibility in terms of the purpose and use of the funds but, like 529 plans, have their own set of drawbacks.

Opening a trust requires a few steps and it’s smart to work with a financial advisor. Check with your financial institution – they will likely have well-versed financial professionals on staff. This individual can help you:

  • Define the purpose of the trust
  • Determine how the investments should be allocated and how much you can contribute to the trust, and
  • Identify who will manage the trust in the event of your passing.

Like a 529 plan, you name a beneficiary for the trust. You can determine when the funds become available to the beneficiary; typically, it’s 18 although you may be able to adjust that to a different age.

Compare the pros and cons of Trusts

Unlike a 529 plan, though, the funds can be used for anything. The beneficiary can opt to use them for their first apartment, a car, or for education. Whether those disbursements are taxed depends on whether they come from the original principal or from earned interest. It’s best to consult with a tax professional to determine tax implications for both you and the beneficiary.

Pros and Cons of a Trust


The Pros of a Trust

  1. Control over the funds and how they are used: One of the significant advantages of trusts is the level of control they offer. As the creator of the trust, you can specify how and when the funds should be used. You can set specific conditions or milestones that must be met before distributions are made. For example, you can stipulate that the funds should be used for educational expenses only or that distributions will be made at certain ages or stages in your child's life.

  2. Asset protection and management: Trusts provide a higher level of asset protection compared to other savings vehicles. When you place assets in a trust, they are no longer considered part of your personal estate. This can offer protection against potential creditors, lawsuits, or financial challenges your child may face in the future. Additionally, trusts can be useful in managing the funds on behalf of your child. The trustee, who is responsible for managing the trust, can ensure that the funds are invested wisely and distributed appropriately according to your instructions.
MHV Fact Friday video

Is it too late to start planning for college? Or too soon?

Get the expert take from Stephanie Goldberg-Mauro, founder of College Planning 101, in this 16-minute video. 

Watch the video
  1. Versatility in terms of purpose and distribution: Trusts are highly versatile and can be customized to meet your specific goals and preferences. Unlike 529 plans, which are primarily focused on educational expenses, trusts can be used for a wide range of purposes. For example, you can establish a trust to provide financial support for your child's education, healthcare needs, housing, or any other specific objectives you have in mind. This flexibility allows you to address multiple financial goals simultaneously and adapt the trust's provisions as circumstances change.
  1. Estate planning benefits, including potential tax advantages: Trusts offer valuable estate planning benefits, helping you manage your assets and distribute wealth efficiently. By placing assets in a trust, you can potentially reduce estate taxes and avoid the probate process. Trust assets typically pass directly to the beneficiaries outside of probate, ensuring a smoother transfer of wealth. This can help your child access the funds more quickly and efficiently, without the delays and expenses associated with probate proceedings.

  2. Continuity and longevity: Trusts are effective tools for long-term planning. With a trust, you can establish a framework that allows the funds to be managed and distributed for an extended period, even after your lifetime. This can be particularly beneficial if you have concerns about how your child may handle a significant inheritance or if you want to ensure that the funds are available to support your child's needs well into adulthood.

Cons of Trusts

  1. Potential costs to set up and maintain: Depending on what kind of trust you establish, there may be setup and administrative fees.

  2. Complexity: Trusts can be more complex than 529 plans, mainly due to their legal nature. Understanding the different types of trusts, such as revocable trusts, irrevocable trusts, or testamentary trusts, may require some legal knowledge or guidance. Navigating through the intricacies of trust law and ensuring compliance with all relevant regulations can be daunting for those unfamiliar with the process.

  3. Limited tax advantages: While trusts can offer estate planning benefits, they may not provide the same level of tax advantages as 529 plans. Trusts are subject to income taxes, and depending on the type of trust, they may face higher tax rates compared to individuals or certain investment vehicles. It's important to consult with a tax professional to understand the tax implications associated with trusts.

  4. Less specialized for education: Unlike 529 plans, trusts are not specifically designed for educational expenses. While they offer flexibility in how funds are used, they may not provide the same level of focus on education-related costs. If your primary goal is saving for your child's education, a 529 plan might be a more suitable option, as it comes with specific tax advantages tailored for educational expenses.

  5. Impact on financial aid: Like 529 plans, trusts can have an impact on financial aid. But, while 529 plans count towards the plan owner’s assets, trusts count towards the beneficiary’s assets. This can have a larger impact on eligibility for financial aid. 4

Questions to help determine if a 529 plan or Trust is better for you

So…What’s Next?

When it comes to saving for your child's future, both 529 plans and trusts offer valuable benefits. A 529 plan is a tax-advantaged savings plan designed explicitly for educational expenses, providing tax-free growth and withdrawals for qualified education-related costs. On the other hand, trusts offer more control, flexibility, and asset protection, allowing you to manage and distribute funds according to your specific wishes.

Choosing between a 529 plan and a trust depends on your goals, preferences, and financial situation. If your primary objective is saving for education, a 529 plan can provide significant tax advantages and a specialized focus on educational expenses. However, if you seek more control, flexibility, and asset protection, a trust may be a suitable option, especially for those with broader financial planning needs beyond education.

Your best bet for next steps? Talk to a financial advisor. They’ll help you navigate all available options and select what’s right for you, your family, and your future.

 

All information provided is for educational purposes only. Consult with a financial professional on your best options. Some products described are not insured. 


  1. https://www.bankrate.com/investing/how-to-open-529-college-savings-plan/#step-by-step-guide
  2. https://www.nysaves.org/home/why-ny-529-direct-plan/tax-benefits.html
  3. https://www.fidelity.com/learning-center/personal-finance/college-planning/college-529-spending
  4. https://finaid.org/savings/trustfunds/#:~:text=Almost%20all%20trust%20funds%20are,affect%20aid%20eligibility%20every%20year.

Other articles you may be interested in