Comparing Coverdell ESA and 529 Plan

There are a number of tax-advantaged college savings vehicles available to help families save for the ever-increasing costs of higher education.  Two of the most popular methods for saving for college are the 529 College Savings Plan and the Coverdell Educational Savings Account (ESA).  Is one of these methods better than the other? How do you choose between the ESA or the 529 savings plan? Let’s take a look.

Choosing Between a Coverdell ESA and 529 Plan

Age Limitations

Perhaps your choice of college savings plan will be determined by age limitations. Contributions can be made to a beneficiary of any age with 529 savings plans, while the Coverdell ESA requires that beneficiaries be under the age of 30.  When it comes time to withdraw money from a 529, beneficiaries can be any age and can use the funds over the course of a lifetime provided they are for approved education expenses.  Funds from a Coverdell ESA must be withdrawn and used by the time the beneficiary reaches the age of 30.

Annual College Savings Plan Contribution Limitations

Coverdell contribution limits max out at $2,000 per year, per beneficiary.  If multiple people are contributing to the same beneficiary’s Coverdell ESA, a maximum of $2,000 can be received, making coordination and communication essential to avoid taxes or penalties.

There are no annual contribution limitations for 529 College Savings Plans.  The amount allowed per plan over the lifetime of the plan varies depending on the state in which the 529 is opened, but ranges from $100,000 to $365,000.

Income Limitations for  College Savings Plan Contributions

Under the 529 plan, it doesn’t matter how much you earn.  Everyone can contribute to a 529 plan.  For the full $2,000 contribution to a Coverdell ESA, you need adjusted gross income (AGI) of less than $95,000 per year for a single tax filer or $190,000 per year for joint filers.  Higher income earners can contribute a smaller amount per year; but if the maximum income limits are reached, the individual may not contribute to a Coverdell ESA at all.

Tax Advantages and Benefits of College Savings Plans

Neither the Coverdell or 529 Plan allow federal income tax deductions on contributions, but the 529 plan may allow tax deductions on state income taxes, depending on your state laws. Earnings in both plans grow tax-free.  Withdrawals from a Coverdell ESA or 529 plan for qualified expenses can be taken federal tax free, as well. Here are some more tax advantages of 529 Plans.

What Are Qualified Withdrawals?

The Coverdell ESA and 529 Plans each have their own list of qualified withdrawals.  For Coverdell ESAs, you can use money for any educational expense from kindergarten to grad school.  Tuition, fees, books, computers, internet access for education, transportation to get to school, private or public school fees, etc.

Money from a 529 plan must be used for higher education expenses at accredited colleges and universities, for educational expenses like tuition, fees, books, and room and board.

How The College Savings Plans Impact Financial Aid

Money in a Coverdell ESA or a 529 plan is considered an asset of the custodian (usually the parent) and not the beneficiary.  If a parent holds the Coverdell ESA, it will be included in the parent’s assets.  Parental assets are assessed at a lower rate than student assets when calculating financial aid awards, which helps minimize the impact of money in an ESA.

Investment Options

Both the Coverdell ESA and 529 account allow for stocks, bonds, CDs and mutual fund investment options.  With the Coverdell, you can change your investment allocations as frequently as you want.  With the 529 plan, you can only change your investment allocations twice per year. Here is more information about how to open a 529 College Savings Plan, and where to open a Coverdell ESA Plan.

Which is Better – Coverdell ESA or 529 Plan??

Overall, the 529 plan is more flexible regarding who can contribute, contribution limits, ages that beneficiaries can use the funds, and it offers the state income tax deduction in some states. The advantages of a Coverdell include more flexibility for investments (ability to open an account virtually anywhere and change investments at will) and it offers slightly more liberal qualified withdrawal opportunities.

Can’t Decide?

If you’re still not sure which college savings option is the best for you, you can actually contribute to both a Coverdell ESA and a 529 plan. These plans are independent of each other.