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How to Make a Trust an Account Owner of a 529 Plan

We explore how it works and its advantages and disadvantages.

Susan T. Bart, 11/19/2003

Most state qualified tuition programs permit a trust to be an account owner of a 529 savings plan. A pre-existing trust from which future distributions may be made to fund the beneficiary's higher education may wish to invest part or all of the trust assets in a 529 savings account to obtain the advantageous income-tax treatment granted to 529 savings accounts. Alternatively, a donor contemplating significant contributions to a 529 savings account may wish to establish a trust for the express purpose of owning the 529 savings account because of the advantages of trust owned 529 savings accounts, discussed below.

How This Works
The trustee would open the 529 savings account with cash already in the trust, with the trust as the account owner and the trust beneficiary as the 529 savings account beneficiary. The trust itself cannot be the beneficiary; an individual must be the beneficiary. The trustee, as account owner, could authorize qualified distributions from the 529 savings account to the beneficiary for the beneficiary's qualified higher education expenses. Such distributions should only be made, of course, if the trust permits distributions to the beneficiary for such purposes. A trust that permits discretionary distributions to the beneficiary for "education" or "best interests" or "welfare" generally should permit distributions for qualified higher education.

Changing the Account Owner
The trustee can also use the 529 savings account to make distributions permitted or required under the trust to the beneficiary by changing the account owner of all or part of the 529 savings account to the beneficiary (assuming the program permits a change of account owner).

For example, if the trustee is required to make a principal distribution to the beneficiary, because the beneficiary has attained a certain age, the trustee could make the beneficiary the account owner rather than taking a nonqualified distribution and distributing the proceeds to the beneficiary. This would be advantageous if the beneficiary has not completed school, because the beneficiary could use the 529 savings account funds on a tax-advantaged basis to pay future qualified higher education expenses and the trustee would not need to take a nonqualified distribution, incurring income tax and a penalty on the account earnings.

If the beneficiary has completed school, it might still be advantageous to make the beneficiary the account owner if the beneficiary may be able to change the beneficiary to a living or future child using his or her annual exclusions and five-year averaging. If a nonqualified distribution must be made, if the beneficiary is in a lower income tax bracket than the trust and the trustee cannot direct the nonqualified distribution to the beneficiary, it would be preferable to change the account owner to the beneficiary and then let the beneficiary take the nonqualified distribution.

The trustee also could make a discretionary distribution to the beneficiary by making the beneficiary the account owner, although there are limited circumstances when this would be advantageous. If the discretionary distribution is made for the beneficiary's qualified higher education expenses, there would seem to be no advantage to making the beneficiary the account owner. In fact, doing so would deprive the trustee of the power to ensure that distributions are used for qualified higher education expenses.

If the intent is to take a nonqualified distribution and distribute the funds to the beneficiary for another permitted distribution purpose, such as support, changing the account owner to the beneficiary would seem to make sense only if the beneficiary is in a lower tax bracket and the program does not permit the trustee to direct a nonqualified distribution to the beneficiary.

Change of Beneficiary
If the trust is for a sole beneficiary, the trustee could not change the beneficiary of the 529 savings account to another individual. However, if the trust is a spray trust for multiple beneficiaries, the trustee could change the beneficiary of the 529 savings account from one trust beneficiary to another trust beneficiary.

Susan T. Bart is a partner in the Private Clients, Trusts & Estates Group at Sidley Austin LLP in its Chicago office, where her practice includes estate planning, estate and trust administration, and fiduciary counsel. She has written two books, including Education Planning and Gifts to Minors published by Illinois Institute for Continuing Legal Education (iicle.com), which extensively discusses 529 plans.

She is the author of Education Planning and Gifts to Minors 2004 Edition. She is a frequent speaker on trust and estate topics in general and Section 529 college savings plans in particular.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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