Monday Money Tip: 529 plan may be better than trust for college

If you are considering putting money aside for your children or grandchildren, you might think a trust is a good idea. But a 529 plan is probably a better one.

So says financial planner Carol Kroch, of Wilmington Trust, a division of M&T Bank.

Partly, that's because income tax rates on a trust are so much higher - in some cases effectively 45 percent. Putting money aside for education can take money out of your estate.

"Compounding is an incredible thing, and if you start early on behalf of your child or grandchild, the account will recover from setbacks in the markets over time," Kroch says.

Even $1,000 a year, say, for your newborn grandchild, adds up once they turn 18 years old: if that amount grows at 4 percent a year for 18 years, it totals $26,000; if it grows at 6 percent that amount totals over $32,000.

Moreover, because income tax rates have become more concerning than estate tax rates for many high-net-worth Americans, they are turning to the 529 plan as a way to get income out of their estate.

"Gifts to educational vehicles such as 529 plans have become a popular way to pay for college, as the income from the plans will not be subject to income tax if it is used to pay qualified higher education expenses," Kroch explained.

Many states also provide an income tax deduction for contributions.

If you want to frontload your gift, you as the 529 donor can do a onetime transfer of five times the annual gift exclusion amount ($14,000) into a 529 plan (for a total of $70,000). However, in that case you can't make other annual exclusion gifts to the child beneficiary of the plan for the next four years.

"It is important to consider whether a gift to a 529 plan is the best use of the annual gift exclusion, but with increased income tax rates in 2013 and 2014, the exclusion from income tax makes 529 plans even more attractive than in previous years," Kroch adds.

While the rules can vary from state to state, the donor can control the investments, control the distributions, and change the beneficiary.