Trust Funds

Trust funds are not effective ways of saving for college if the beneficiary expects to qualify for need-based student financial aid.

A trust fund is a legal entity established by a grantor to hold property, such as money, investments and other assets, for the benefit of one or more beneficiaries. The trust fund’s assets are managed by a trustee according to the terms of the trust. The trustee may distribute the income and/or principal balance of the trust periodically to the beneficiaries.

Advantages of Trust Funds

Trust funds provide several advantages that may appeal to wealthy families, such as estate and tax planning benefits, confidentiality and control. A trust fund allows a family to pass assets outside of probate, potentially reducing estate taxes and keeping the details private. A trust fund can ensure that the grantor’s wishes are carried out, which can be useful if the grantor is concerned about whether the beneficiaries can make wise decisions. For example, a trust fund can prevent a child from spending his or her college savings on a sports car.

Disadvantages of Trust Funds

Trust funds are not, however, effective at sheltering money from student financial aid formulas, even if the trust restricts the beneficiary’s access to principal. Trust funds are reported as assets on the Free Application for Federal Student Aid (FAFSA), per the Higher Education Act of 1965 [20 USC 1087vv(f)(1)]. A trust fund should be reported as an asset of the beneficiary, in proportion to the beneficiary’s share of the trust. If the trust fund does not specify each beneficiary’s share of the trust, an equal split should be assumed. Any debts or liens against the assets of the trust should be subtracted before determining the beneficiary’s share of the net value of the trust.

A trust fund must be reported as an asset, even if the grantor has voluntarily placed restrictions on access to the principal balance of the trust. These restrictions may be involuntary from the perspective of the beneficiary, but the trust fund is still considered an asset of the beneficiary.

There are only a few exceptions to reporting a trust fund as an asset:

  • If a court order establishes involuntary restrictions on access to the trust, such as a trust fund established to pay for future medical expenses of an accident victim, the trust fund is not reported as an asset.
  • If ownership of the trust is being contested in court and access to the trust has been frozen, the trust fund is not reported as an asset until the case is resolved. This can occur in divorce proceedings or when a testamentary trust (a trust established by a will) is being disputed.
  • If the existence of the trust is unknown to the family. 

The restrictions on access to the trust fund only serve to prevent the beneficiary from liquidating the trust. This means that the trust fund will continue to be reported as an asset each year, reducing the beneficiary’s eligibility for need-based financial aid year after year.

Examples of trust funds that do not shelter the trust fund’s assets from need analysis include blind trusts, Crummey Trusts, Section 2503(c) Minor’s Trusts, Spendthrift Trusts, Special Needs Trusts and various charitable trusts (e.g., GRAT, CRAT, CLAT, CRUT and CLUT).

Split Ownership of Principal and Interest

If ownership of the income and trust principal has been split, a net present value calculation will be necessary to determine the current value of the beneficiary’s ownership of the trust. The net present value effectively is the current cost of an investment that would reproduce the future payments with no money left over.

To calculate the net present value, discount each of the future payments to determine the equivalent current value of each future payment. For example, consider how much money would need to be invested in an account earning 5% interest after taxes to make annual payments of $100 a year for the next ten years, with no money left over? A payment of $100 in one year would require a current investment of $100 / 105% = $95.24 now with a 5% after-tax return on investment. To receive a payment of $100 in two years would require a current investment of $100 / (105% x 105%) = $90.70, if the interest is compounded annually. Summing similar calculations for each of the ten payments of $100 yields a total current investment of $772.17.

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