If you want to set aside money to pay for a loved one’s education, you could set up an educational trust.
An educational trust specifies that trust funds are to be used for education. In the trust document, the grantor names a trustee and beneficiaries, and also states how trust money is to be used. If the trust will become operational immediately (see below about this), then the grantor “funds” the trust by transferring property into it. If the trust becomes operational upon the grantor’s death, then the trust is funded when the grantor dies. When the trust becomes operational, the trustee controls trust property – and pays for the beneficiary’s education -- according to the terms of the trust.
When you make an educational trust, you decide the terms of the trust – including, who will control the trust, how the trust property will be used, and who will benefit from the trust. Here are some issues to consider.
Do you want the trust to become operational during your life (a living trust), or at your death (a testamentary trust)?
If the beneficiary isn’t likely to need trust funds until after you death – for example, if the beneficiary is quite young, and you are close to the end of your life – then it probably makes the most sense to have the trust go into effect when you die. That way, you don’t have to worry about funding the trust (and the gift tax issues that might follow) now.
However, if you expect the beneficiary to need trust funds soon, you can put the trust into effect now. You will also have to fund the trust now, but you can put as much or as little into the trust as you want. Unfortunately, funding the trust now may create gift tax consequences. Gifts of more than $13,000 per year per recipient made during your life are subject to gift tax. Gifts transferred to a trust as a result of your death are not subject to this tax.
Read more about the Estate and Gift Taxes
When you create your trust, you will need to decide who will be the trustee. While the trust is operational, the trustee controls the trust and has the power to spend trust funds according to the terms of the trust. For an educational trust, the trustee will follow the terms of the trust to pay for the beneficiaries education.
If you create a testamentary trust—one that takes effect after you die – then you only need to name a trustee and an alternate. However, if you create a living trust – one that takes effect during your lifetime, then you will probably name yourself to be the initial trustee, and you’ll need to think about who will be your successor trustee when you die.
When naming the trustee (or the successor trustee, if you make a testamentary trust) consider who will be the best person to control the trust after you are gone. It should be someone you trust (obviously), and it should also be someone who is also familiar with your wishes for the trust and with the beneficiaries needs. It might be your spouse, your adult child, or the beneficiary’s parent. Be sure to name an alternate, in case your first choice isn’t available or can’t do the job.
Do you plan to contribute to the educations of more than one beneficiary? If so, do you want separate trusts for each, or one trust for all? And if you make just one trust, you’ll how should the trustee to divide up trust funds? Will each beneficiary get a set amount or percentage? Or will you make a sprinkling trust that puts trust funds in a “pot,” leaving the trustee (with guidance from the terms of the trust) to determine who gets what.
Using a pot trust gives the trustee the most flexibility to meet the unique needs of each beneficiary. This may be particularly useful if the beneficiaries have very different needs or if their needs are not yet known. However, a pot trust puts an extra burden on the trustee, and it could create strife amongst the beneficiaries and trustee when the trustee decides to spend more on one beneficiary than another.
Learn more about Sprinkling Trusts on Nolo.com.
Do you have a certain type of education in mind for your beneficiary? Will it be okay with you if the beneficiary uses funds from your trust to go to either trade school or medical school? Can trust funds be used to go to school part time – or online? You can use the trust to determine for what type of education the trustee can use trust funds. Of course it will be easiest for the trustee (and the beneficiary) if you are open to any kind of education. But the most important thing is that the trust gives the trustee clear guidance as what can and cannot be done with trust funds.
If all goes as planned, the trust may end when all of the trust funds have been spent on a good education for your beneficiary. However, you’ll need to consider some other possibilities. What should happen to trust funds if:
In the terms of your trust, you’ll need to consider these scenarios and make plans for them. For example, you may decide that if there is still money in the trust when the beneficiary turns 30, then he or she should get the money outright. Or maybe it should be made available to a different beneficiary.
You’ll need a lawyer to write your educational trust. However, you can save some money by educating yourself before you hire an attorney. Visit Nolo.com to learn more about:
Also, learn more about other ways to set money aside for a child’s education using Educational Savings Plans.