529 College Savings Plan vs. Coverdell ESA

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As part of our preparation for parenthood, my wife and I have been examining college savings programs. The two most common college saving plans are the 529 College Savings Plan and the Coverdell Educational Savings Accounts (ESAs). 529 College Savings Plan vs. Coverdell ESA Similarities. These college savings plans both work similar to Roth IRAs…

As part of our preparation for parenthood, my wife and I have been examining college savings programs. The two most common college saving plans are the 529 College Savings Plan and the Coverdell Educational Savings Accounts (ESAs).

529 College Savings Plan vs. Coverdell ESA

Similarities. These college savings plans both work similar to Roth IRAs – contributions are non-deductible and grow tax free. Withdrawals are also tax free for qualified higher education expenses. 529 Plans and Coverdell ESAs are viewed the same for financial aid purposes. They are considered the assets of the custodian (the person who opened the account), and withdrawals by the beneficiary are not considered taxable income when used for college expenses. Both plans can be transferred to another beneficiary without penalties or fees.

Differences. The major differences between the 529 Plans and Coverdell ESAs are listed below.

Types of accounts:

Control of account:

  • 529 Plan: Account holder controls when withdrawals will be made and for what purpose, and can change beneficiaries at will. There are no restrictions regarding when funds must be used.
  • ESA: Account holder can change beneficiary at will. If money is not transferred to a new beneficiary or used for higher education costs, then the beneficiary receives the assets when they turn 30 and the account will be assessed taxes and penalties.

Age limit for contributions and withdrawals:

  • 529 Plan: None.
  • ESA: Must be under 18 to receive contributions, must use assets before age 30.

Contribution limits:

  • 529 Plan: Between $100,000 and $350,000 depending on state
  • ESA: $2,000 per year from all sources

Income limits for contributors:

  • 529 Plan: No income limit.
  • ESA: To qualify for the max $2,000 contribution, your AGI must be less than $95,000 for single filers and $190,000 for married couples. Contributions will drop to $500 per year in 2010 if Congress does not extend the current limits. More about ESA contribution limits.

State tax deductions or credits for contributions:

  • 529 Plan: Yes, depending on state plan and residency.
  • ESA: No.

Uses for plan assets:

  • 529 Plan: Higher education only.
  • ESA: Through 2010 assets can be used for K-12 and higher education.

Investment options:

  • 529 Plan: Stocks, bonds, mutual funds, CDs. Can only change investment allocation 2 times per year.
  • ESA: Stocks, bonds, mutual funds, CDs. No limit to changes in investment allocation.

529 College Savings Plan offers more flexibility than a Coverdell ESA

In my opinion, the 529 Plan is a more versatile plan, especially if you will have other people contributing money toward your child’s education – the $2,000 limit for ESA contributions is more difficult to track when there are multiple people contributing.

The Coverdell does have several advantages, including the ability to use the funds for K-12 (through 2010 unless extended), make unlimited changes to asset allocation, and ESAs may have better investment options, depending on the state in which you open your 529 College Savings Plan.

The good news is that you can have both plans for your children and you can roll a Coverdell ESA into a 529 College Savings Plan. These plans have a lot of small print and conditions, so I recommend reading the details for your state 529 plan or reading more about the Coverdell ESA before opening an accout and making contributions.

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About Ryan Guina

Ryan Guina is the founder and editor of Cash Money Life. He is a writer, small business owner, and entrepreneur. He served over 6 years on active duty in the USAF and is a current member of the IL Air National Guard.

Ryan started Cash Money Life in 2007 after separating from active duty military service and has been writing about financial, small business, and military benefits topics since then. He also writes about military money topics and military and veterans benefits at The Military Wallet.

Ryan uses Personal Capital to track and manage his finances. Personal Capital is a free software program that allows him to track his net worth, balance his investment portfolio, track his income and expenses, and much more. You can open a free account here.

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  1. LeeAnne says

    I have a question about withdrawing from a 529. After much searching on this issue, I have come up with different answers. If you withdraw from a 529 in the same year you received a financial aid student loan, can you use the withdraw to pay back the loan. I have read that as long as you do it in the same year, yes you can. Is this true? For example, my daughters tuition was approx. 11,000 this year she received 8,000 in loans, the rest in scholarships. Can I use the 8000 she has in a 529 to pull out and pay back the loans this year? This is her last year of college.

    • Ryan Guina says

      LeeAnne, I don’t have a confirmed answer for you. I recommend you contact a tax professional to make sure you get the most up to date information.

  2. Daniel says

    Hello, can I contribute to the maximum of $2,000 to the ESA account of my son if I am a divorced parent? I do not know if my ex-spouse has opened any ESA account or how much she might have put in it. Apparently I do not want to do any “coordination” with my ex- on this contribution. Thank you.

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