Should I Open a 529 Plan or a Trust for My Children and/or Grandchildren: The Pros and Cons

By: Anthony J. Enea, Esq.

Before addressing 529 Plans and/or trusts for education and related savings, let me begin by saying I am reluctant to recommend an UTMA (Uniform Transfer to Minors Act) account as a means for saving for the education of a child and/or grandchild, the sole reason being that, upon attaining the age of 21 in New York, the 21-year-old can withdraw the money from the account. It becomes their money to do as they please.

529 Plans, on the other hand, provide more structure. They have a number of positive virtues as well as detractors. Section 529 of the Internal Revenue Code (IRC) governs the creation of these tax-deferred savings plans, which are designed to help finance the ever-increasing costs of higher education. 529 Plans are available in all 50 states and in the District of Columbia. They come in two basic varieties: a pre-paid tuition plan (less popular) and the 529 College Savings Plan. For purposes of this article, we will focus on the 529 College Saving Plans.

While the rules and fees for every plan may vary from state to state, in general 529 College Saving Plans offer the following:

1. All plans offer tax-deferred growth for both Federal and New York State income taxes. However, New York, unlike many other states, does not allow tax-free withdrawals for K-12 educational expenses. The withdrawals are tax-free as long as they are used for qualified education expenses such as tuition, fees, and room and board.
2. You can deduct up to $10,000 in contributions if you are married (and file jointly) and $5,000 in contribution if you are single. Remember, for 2025 one can make tax-free gifts of $19,000 per person per year. Five years of annual gift tax exclusions are permitted, which translates to $95,000 for a single person and $190,000 for a married couple—a significant savings.
3. The contribution limit in New York is $520,000, and you can change the beneficiary to another eligible family member if the original beneficiary doesn’t attend college.
4. In New York, the direct plan is managed by Vanguard, a highly regarded and low-cost fund manager.
5. “Qualified Educational Expenses” includes most eligible public and private universities, vocational schools, and apprenticeship programs nationwide and abroad, which allows for a wide range of educational opportunities for the plan beneficiary. A qualified expense is also the repayment of student loans that are not in excess of $10,000.
6. New York State also allows the rollover from a 529 Plan to a Roth IRA for the plan beneficiary in an amount up to $35,000.

All of the above are generally advantageous, however, there are definite drawbacks to 529 College Savings Plans as well:

1. If you take a withdrawal for “non-qualified” educational purposes, the withdrawal portion is subjected to both state and federal income taxes, plus a 10% federal penalty.
2. K-12 education in New York is a non-qualified education expense. Thus, if it has been decided that your child and/or grandchild is best served by a private/religious school and/or high school, you will have to recapture any state tax deduction taken.
3. With a 529 Plan in New York, you are limited to the Vanguard Plan as the investment vehicle and fund manager. You don’t have the ability to switch to another fund manager, and thus, your investment options are limited.
4. If you have moved to another state and roll over the New York 529 Plan to the 529 Plan of the other state, New York will consider that a non-qualified withdrawal, which will trigger a tax recapture on any earnings and deductions.
5. The plan can end up being overfunded if the beneficiary doesn’t attend college, and if there is no other qualified beneficiary there will be taxes and penalties to be paid.
6. If the parent (not grandparent) owns the 529 Plan, the plan will count as the parent’s assets on the FAFSA (student aid) form, which can impact eligibility for need-based financial aid.

In my opinion, there are too many restrictions, limitations, and potentially negative tax consequences in using a 529 Plan when compared to the creation of an Irrevocable Trust and/or a Revocable Trust for the benefit of a child and/or grandchild. For purposes of this article, we will focus on the Irrevocable Trust:

1. For starters, with the use of an Irrevocable Trust, there are no limitations on how the funds can be used for the beneficiary. The creator of the trust (the Grantor) establishes the parameters for the use of the trust funds for the benefit of the beneficiary(ies). The funds can be used for any purpose the trust creator wishes (within the law), including, but not limited to, the health, education, maintenance and support of the beneficiary. Specifically, there is no limitation on whether the funds are used for K-12 or higher education, and the trust can be created regardless of the state in which the beneficiary resides.
   Also, many children do not go to college, but seek an entrepreneurial path, such as starting their own business, or take a gap year to travel or do charity work. With a trust, the Trustee (one or more persons selected by the trust creator) has the ability to decide how and for what purpose the trust funds will be used. While the funds can be used for higher education, they can also be used for other purposes, like the purchase of a new home for the beneficiary, or the investment in a business in which the beneficiary will be a principal and/or a majority shareholder.
2. With a trust, there is no limitation on the investment options—you are not limited to one fund or another. The options are endless, subject to the investments available and the Prudent Investor Rule (requiring diversity of investments).
3. While there is no tax deferral for income tax purposes with the use of a trust, a trust can be structured as a “Grantor Trust” so that the creator of the trust is responsible for the payment of any income taxes on dividends, interest income, and capital gains taxes generated by the trust assets.
   Thus, the Grantor (parent/grandparent) would pay the taxes at their own income tax rate, and the payment thereof would not be considered a taxable gift by them. This would avoid the trust paying the taxes at a higher and more compressed tax rate for trusts—the trust assets would grow without payment of income taxes.
4. The trust can specify when any or all of the trust assets will be distributed to the beneficiary. The creator of the trust can select a specific age at which the assets are distributed to the beneficiary outright or, in the alternative, can direct that the trust continues for the life of the beneficiary. Even if a specific age is selected, the Trustee can still withhold distributions to the beneficiary if the trust language provides that they can do so and if it is not in the best interest of the beneficiary to release the funds outright at that point (for example, if the beneficiary has an alcohol/drug addiction, is in the midst of a divorce, and/or is filing for bankruptcy). Likewise, if the Trustee feels that the beneficiary is mature enough to handle an outright distribution sooner than the age specified in the trust, the Trustee has discretion to distribute the trust funds to the beneficiary earlier than initially specified.
5. Because the trust is irrevocable, the trust assets do not belong to the beneficiary until they are actually distributed to them. Thus, said assets are protected from the claims of creditors of both the trust’s creator and beneficiary(ies).

As can be seen from the above, the flexibility provided with the use of a trust for the payment of educational (or other) expenses of the beneficiary, along with the creditor protection benefits is significant. While there are some advantages associated with a 529 Plan, there is no question that a trust provides more options and can be structured based upon the personal circumstances of both the trust creator and the beneficiary, to provide support when needed as your loved one moves forward into adulthood.

*Anthony J. Enea is the managing attorney of Enea, Scanlan & Sirignano, LLP of White Plains, and Somers New York. He focuses his practice on Wills, Trusts, Estates and Elder Law. Anthony is the Past Chair of the Elder Law and Special Needs Section of the New York State Bar Association (NYSBA) and is the past Chair of the 50+ Section of the NYSBA. He is a Past President and Founding member of the New York Chapter of the National Academy of Elder Law Attorneys (NAELA). Anthony is also a Past President of the Westchester County Bar Foundation and a Past President of the Westchester County Bar Association. He is fluent in Italian. He can be reached at (914) 948-1500 or at [email protected]