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Does the beneficiary pay taxes on an educational trust?

An educational trust is a way to leave money to a beneficiary so that they can pay for college. Often, the person who sets up the trust specifies that the only way the money can be used, at least until the student graduates, is to pay for their education.

What they may wonder, then, is if they have to pay taxes on this money. Does it count as income when they get those payouts every year?

There are two things to consider. First is the principal amount that the person put into the trust when it was created. The beneficiary generally does not have to pay any taxes on this money, as the person who established the trust will already take care of any financial obligations at that time.

That said, the trust may be set up to create more income through investments and similar sources. This is common when the beneficiary is very young at the time -- a grandparent setting up a trust for a grandchild's future schooling, for instance, even though that person won't go to college for a decade.

If so, then the amount that was earned is taxable in most cases. The trust may have to pay the taxes or the beneficiary may need to do so. It depends on the terms that were used when it was established. Examples of income include dividends, ordinary income, interest and capital gains.

As you can see, it is very important for everyone involved with this process to understand exactly what steps they need to take and what financial obligations they may have.

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