Most families stress over the overwhelming costs of sending their children to college, but the most important thing is having a plan in place before you start sending out those applications. The most important step throughout this process would be to set up a college fund as soon as possible. 529 Plans and Coverdell accounts are two of the most common education savings plans that can give you and your child a head start toward education funding.
529 Savings Plans
A 529 savings plan is a tax-advantage education savings vehicle that can be used to help fund a college education. Each 529 plan has an account owner, who is the person that opens the account, as well as a beneficiary who is the one for whom contributions are being made for. Contribution limits do vary based on the state you are in, but they are generally very high. When looking at tax advantages, any contributions made to a 529 plan will accumulate tax deferred, and the earnings will be tax free at the federal level (and typically state tax free) assuming the money is used to pay for the beneficiaries qualified education expenses. Qualified education expenses include tuition, room and board, books, computers, tutoring, as well as any other education expenses required by the school.
There are a few drawbacks that you should be aware of before you begin funding a 529 savings plan. One being penalties if you use the funds for non-qualified education purchases. If the funds are used for non-qualified education expenses the earnings portion of the withdrawal will be subject to income tax and a 10% federal penalty (State income tax and a penalty may also apply). The other drawback is that 529 plans offer less investment control. Regarding the flexibility of your investments, you’re limited to the investment portfolios offered by the plan that you select.
Coverdell Accounts
Coverdell education savings accounts (ESA) is another tax-advantage education savings vehicle that is much like a 529 plan. Contributions to a Coverdell ESA Like 529 plans, a Coverdell ESA can be used for qualified education expenses for the beneficiary of the account. One of the benefits to a Coverdell ESA is that they offer much more investment flexibility compared to a 529 plan because you can generally buy and sell investments whenever you’d like. A Coverdell ESA also gives you the option to roll the account over to a different trustee while keeping it in the same beneficiary’s name or designating it to a new beneficiary within the same family.
Coverdell ESAs are a great option to help save for education, although when comparing them to 529 plans they are much more restrictive. One major difference is that a Coverdell ESA has an annual contribution limit of $2,000, which is much less than the lifetime maximum contribution for a 529 plan which is typically $350,000 and higher depending on the plan you choose. Second, when it comes to Coverdell ESAs, there are income limitations to become eligible to contribute. For single filers, you must have modified adjusted gross income (MAGI) under $110,000, while married filers must have MAGI under $220,000. One final drawback to note is that you can’t contribute to a Coverdell account for a beneficiary who is 18 or older. On the flip side, a 529 plan doesn’t have restrictions based on income, and you can generally continue to contribute after the beneficiary turns 18.
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