Over the years clients have asked me how to provide for educational gifts within their estate plan, specifically with trust planning. While a variety of tax-favored educational accounts exist like state-sponsored prepaid college tuition plans or Section 529 accounts, today I’m going to limit the discussion to the creation of a trusts for these purposes.
There are two types of trusts: lifetime gift trusts or testamentary (after death) trusts. Both can be built inside an estate plan and can serve the same purpose. Since most of my clients have children or grandchildren who need the money now rather than waiting until the clients’ demise, lifetime education trusts are more common.
Assuming you want to benefit multiple beneficiaries, there are two different types of educational trusts. One would be a “pooled” trust where the sums contributed can be allocated among the beneficiaries as the trustee determines, while the other would be “separate share” trusts, where the amounts contributed are divided proportionately among the beneficiaries.
The advantages to a pooled trust include the fact that the amounts can be used disproportionately among the beneficiaries. The ones who have the greatest need would presumably consume more of the trust. This is also the most challenging problem to a pooled trust, and why I usually recommend avoiding this technique.
Assume, for example, that Jane and Joe contribute $240,000 to a pooled trust, and they have three grandchildren, Bob, Charles and Denise. Bob is the first grandchild who attends Harvard at a cost of $70,000 annually. By the time his siblings Charles and Denise start college, Bob’s educational expenses have consumed the entire trust.
Over my career I have drafted several pooled educational trust funds. In some of those instances, beneficiaries fought over access to the funds. The trustee has a fiduciary duty to all beneficiaries. Imagine a trust where the oldest beneficiary is already in college but one of the beneficiaries is a toddler. How much should the trustee allow the first beneficiary to consume, knowing that the trustee has a fiduciary duty to the younger beneficiaries to have something left for them?
Consider further that with the rise of college tuition – outpacing inflation even – how should the trustee allocate funds as each beneficiary attends school? Add to that the difference in cost between a state school and a private institution and you have a real trustee conundrum.
Suppose that Jane and Joe instead impose a limit on the amount that any one beneficiary can consume to avoid the above problem. In that case, why not instead have separate trust shares? Here, Jane and Joe instead fund an educational trust with $240,000 for Bob, Charles and Denise but create separate $80,000 shares for each. When the amount is consumed then that’s all that the beneficiary would have. If the older beneficiaries don’t consume their entire share, either the remainder is distributed outright to them at an certain age or it instead would be added to the younger beneficiary’s shares.
You might see that there’s much thought that should be put into the planning behind an educational trust. I haven’t even touched upon several other issues that should be thought through. These include who should act as the trustee, how the funds should be invested, whether a beneficiary’s other resources should be considered before making distributions, or whether vocational education would be treated similarly to a more traditional bachelor’s degree.
Ultimately, providing for a young person’s education is one of the best gifts you can bestow. It’s akin to the proverbial teaching a man to fish rather than giving him a fish. When you provide a youngster a means to make a living, then you’ve passed something more valuable than anything else they can inherit.
© 2018 Craig R. Hersch. Originally published in the Sanibel Island Sun.