Free College Education Trust

Many parents (and grandparents) are interested in accumulating funds for the future college education of their children. Often the parents are interested in having the earnings on the funds taxed to their children at lower income tax rates, but at the same time do not wish to give up control over the use of the funds. Custodial accounts are sometimes used, but in most states a child must be given access to such funds at age 18 years. This requirement causes concern for parents who believe that 18 year olds might not wisely use the custodial account funds.

The College Education Trust document is a special trust that meets the requirements of Section 2503(c) of the Internal Revenue Code. Gifts to the trust for the benefit of a child are not subject to federal gift and estate taxes if the gifts are less than $10,000 per year. The income from the funds is either taxed to the trust (if no distributions are made from the trust) or to the child (if distributions are made to the child). Often the income will be taxed at lower tax rates than the rates of the parents. At the same time, the parents can use the trust to maintain some control over the use of the funds. Further, unlike a custodial account arrangement, there are no restrictions on the types of assets that can be transferred into the 2503(c) trust.

There are certain requirements for the "Section 2503(c) trust" as follows:

• The assets of the trust must be available for distribution to the child while the child is under the age of 21 years. See The Trust's Beneficiary topic for more information.

• The assets of the trust must be distributed to the child when the child attains age 21 years. See The Trust's Beneficiary topic for more information. See also Continuation of the Trust topic for information about continuing the Trust beyond age 21 years.

• If the child dies before reaching age 21 years, the trust assets must be distributed either to the child's estate or to beneficiaries that the child designates in the child's will or other written document. See the Alternate Distribution If the Beneficiary Dies topic for more information.

Another requirement for the trust is that the assets of the trust must be distributed to the child (beneficiary) when the child attains age 21 years. This requirement can be a concern if substantial assets remain in the trust at that time. However, with the beneficiary's cooperation the trust can be continued.

Generally, the recommended approach for continuation of the trust is to give the beneficiary the option to extend the trust by having the beneficiary give notice to the trustee that the beneficiary wishes to do so. Although there is no guaranty that the beneficiary will make this choice, most beneficiaries can be encouraged to do so.

If the beneficiary elects to continue the trust, the provisions of the trust provide for a later date for the termination of the trust, for example, when the beneficiary reaches age 30 years. During this period after the beneficiary attains age 21, all of the trust income is paid to the beneficiary, and additional distributions can be made if necessary.

The trustee should provide a financial report at least annually and preferably more often. The financial report should show the trust's investments and other assets, income, expenses, and distributions (if any) to the beneficiary. These reports should be provided to the grantor, and if the grantor is no longer living, then to the beneficiary or the beneficiary's parent or guardian.

In some states a trust is not valid unless some asset is contributed into the trust at the time that the trust agreement is signed. Therefore, at least a nominal amount, perhaps $100, should be contributed into the trust to establish it.

Each donor can contribute up to $10,000 per year to the trust without liability for federal gift taxes. For example, parents can contribute $20,000 to the trust on an annual basis.

Unlike trusts that use "Crummey" powers, there is no requirement that the beneficiary be given an opportunity to withdraw funds each time a gift is made to the College Education Trust. This factor is viewed as a major advantage over the more traditional "Crummey" trust.

It is not advisable to have the grantor or a parent serve as the trustee (and frequently, the grantor is also a parent). If the grantor serves as trustee, the assets of the trust will be included in the grantor's estate - an undesirable result. Similarly, if a parent has the authority as the trustee to make distributions to a minor, the trust assets will be included in the parent's estate (whether or not that parent is the grantor) - also an undesirable result.

Therefore, it is recommended that a bank or other institution with trustee services (e.g., some brokerage firms) serve as the trustee. It is also possible to name some other individual, perhaps a relative or family friend, as a trustee. A successor trustee should be designated to provide for the possibility that the initial trustee will be unable or unwilling to serve as trustee in the future (e.g., resignation, poor health).

1. The College Education Trust should be signed by both the Grantor and the Trustee. It is recommended that the signatures of the Grantor and Trustee be notarized.

2. The date should be filled in on the first page of the document and in the signature areas at the end.

3. The original copy of the trust agreement should be kept in a secure location such as a safe deposit box at a bank. A photocopy should be given to the initial trustee. A second photocopy could be kept in the Grantor's home files. The Grantor may wish to provide a copy to the successor trustee.

Typically, the beneficiary of the College Education Trust is a child who is several years or more away from starting college. The parents (and perhaps) grandparents expect to contribute significant amounts to the trust over a period of years. The parents can each contribute up to $10,000 per year. Thus, two parents and four grandparents working together could contribute up to $60,000 per year. When the child reaches college age, often 18 years of age, distributions for college expenses can be made. There should only be one beneficiary per trust. Therefore, if there is more than one child, multiple trusts should be used.

One requirement for the trust is that the assets of the trust must be available for distribution to the child while the child is under the age of 21 years. To meet this requirement, the trust typically provides that until the beneficiary attains the age of 21 years, the trustee may distribute as much of the trust funds for the beneficiary's benefit as the trustee (in the trustee's sole discretion) may determine is necessary for the beneficiary's health, education, and support. This does not mean that the trustee has to make any distributions prior to the need to pay college expenses � it only means that the trustee must have the authority to do so.

Another requirement for the trust is that the assets of the trust must be distributed to the child when the child attains age 21 years. In some cases this requirement is not viewed as a concern, because significant trust assets have already been paid out for college expenses by the time the child becomes 21 years old. However, this requirement can be a concern if substantial assets remain in the trust at that time. To plan ahead for this possibility, many college education trusts provide for the Continuation of the Trust.