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The Wealth & Wisdom Blog

Information on Estate Planning, Estate and Trust Administration and Unique Asset Planning

Golf is a game whose aim is to hit a very small ball into an even smaller hole with weapons singularly ill-designed for that purpose.”  Winston Churchill.

As a golfer, I have come to realize, through many poorly-played rounds, that the use of the correct “tool” (that is, club selection) is of critical importance in executing the appropriate strategy.  For those endeavoring to complete a home improvement project, I am told that having the appropriate tool on hand is key to the efficient completion of your project.

Over the past few months, I have had the pleasure of representing several clients who have shared a common planning objective: to provide for the educational costs of their grandchildren.  Ideally, a grandparent will have the personal satisfaction of seeing their granddaughter or grandson move the tassels on their cap and hear Pomp and Circumstance at a post-pandemic graduation ceremony.   Just as certain tools are better than others when it comes to golf or home improvement projects, the most appropriate gifting strategy should be customized for each family.  In this month’s update, I provide a brief overview of four different gifting strategies that grandparents could implement to assist grandchildren with educational costs.

Revocable Trust 529 Plan Accounts Irrevocable Trusts Retirement Accounts
Income Taxes Payable by Grantor None, so long as used for education Paid by trust or by grantor Ordinary income on withdrawal
Subject to Estate Taxes Yes No No Yes
Limitations on Control None None Grantor cannot retain control None
Limitations on Use None Must be used for educational costs Trust Agreement specifies Once withdrawn from IRA, no limitations

Revocable Trust Account.  First, grandparents could own funds earmarked for a grandchild’s educational costs through a revocable trust-owned taxable account.  This approach provides the grandparents the most flexibility, not only to change the identity of the beneficiaries, but perhaps also the purposes for which the earmarked dollars are spent.  At death, the remaining assets could flow into testamentary trusts created to pay for these educational expenses.

College Savings (“529”) Plans.  Second, grandparents could create one or more college savings plans (so-called “529 Plans”) for their grandchildren.  There are two key tax benefits of this approach: (i) the assets are never subject to estate taxes; and (ii) the earnings, dividends and interest are not subject to income taxes so long as assets are used only for educational costs.  While a trust can become the owner of a 529 Plan account after the grandparent’s death, the limitations on the use of the 529 Plan assets, as well as limited investment options, dissuades some grandparents from implementing this strategy.

Irrevocable Trust(s). Third, grandparents could create one or more irrevocable trusts for the benefit of their grandchildren.  For clients who face estate tax exposure and who are able and willing to relinquish control of their assets, this is a good “set it and forget it” strategy.  Other family members (e.g., adult children) can be named as the trustees. While the continuing income tax obligations make this strategy less attractive vis-à-vis a 529 Plan strategy, it provides the trustees with far more flexibility in making investments and making distributions for a wider array of beneficiaries and purposes.

Inherited Retirement Accounts.  Fourth, clients could direct the creation of one or more testamentary trusts to pay for educational funds following death, and then partially or fully fund these trusts with remaining retirement account assets.  By reason of the enactment of the “SECURE Act,” most beneficiaries receiving an inherited IRA account can no longer “stretch” the timeframe for paying income taxes on inherited IRAs.  As a result, using remaining retirement account assets to fund specific bequests (e.g., educational trusts) is less “costly” from an income tax perspective now than under previous law.

Regardless of which of these four strategies is implemented, it is critically important that the gifting strategy be coordinated with the grandparent’s estate plan.  Attempting to implement the remaining portion of a grandparent’s gifting strategy following the death of a client might be like the golfer who is forced to use his driver on the putting green–suffice it to say, not the intended and proper use of a driver.  However, even if the implementation of the remaining portion of the gifting plan turns out to be less than an ideal tax outcome, if the gifting plan is coordinated properly, the plan will have succeeded in funding the intended objectives.