If you're a parent, you can't afford to waste any time when it comes to saving for your child's future. With education costs steadily increasing, it's important to start saving for college as soon as possible and you have many savings options available, including the Coverdell ESA and the 529 plan. Each of these savings vehicles offers unique advantages and disadvantages when it comes to saving for your child's education.
Eligiblity
To invest funds in a Coverdell Education Savings Account (ESA), your adjusted gross income may not be more than $110,000 if you file singly or $220,000 for couples filing jointly. Funds in a Coverdell ESA are held in a custodial account solely for the use of your dependent.
Anyone may contribute to a 529 college savings plan, regardless of income, and funds may be used for anyone, including your child, another relative or even yourself.
Contribution Limits
The maximum you can contribute to a Coverdell ESA is $2,000 per student annually until they reach age 18. Each state regulates contribution limits for its 529 plan and current annual contribution limits range from $100,000 to $305,000 and there are no restrictions on the student's age.
Qualified Withdrawals
You may withdraw funds from a Coverdell ESA without incurring an income tax penalty if the money is used to pay for tuition, fees, supplies, and room and board for students attending elementary, secondary and postsecondary institutions.
You may make withdrawals tax-free from a 529 plan if funds are used for tuition, fees, or room and and board at qualifying higher education institutions only.
Benefits
The primary advantage of the Coverdell ESA is that it provides you with a wider range of investment choices than a 529 plan and investments can be bought and sold according to your wishes. Both the Coverdell ESA and the 529 allow assets to be transferred to another beneficiary, so long as they're a member of your immediate family. Depending on your state's plan, you may be able to deduct contributions to a 529 plan and funds won't have an impact on your student's financial aid eligiblity.
Considerations
With a Coverdell ESA, account control transfers to the student at age 18. If funds are not used by age 30, they may be subject to a 50 percent tax penalty. Funds held in an ESA are also considered an asset of the student when determining financial aid eligiblity. With a 529 plan, you have less flexiblity in your investment choices and you may only make changes to the plan once per year. With both plans, nonqualified withdrawals are subject to a 10 percent penalty and earnings are subject to regular income tax.
