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College Savings Options: Coverdell ESAs and 529 Plans

Take a closer look at your education savings options to decide which is right for you.


Bottom Line Up Front

Putting money away for your child’s future education will help them graduate with less student loan debt, and you may get state and federal tax breaks as you save. A state 529 plan offers tax-free investment growth for money used for qualified higher education expenses. A Coverdell Education Savings Account is another alternative with its lower contribution limits but more flexibility and tax advantages.

When planning for your child’s future, saving early for college tuition is the smart way to go. The sooner you start toward your savings goals, the more time your money has to grow. And, the more you and your future student have saved, the less they’ll need to rely on student loans and other financial aid. Two options that offer tax-advantaged† ways to save are 529 college savings plans and Coverdell Education Savings Accounts (ESAs). Here’s a closer look at each.

529 College Savings Plan

In these accounts (usually sponsored by states), contributions grow tax free, and withdrawals for eligible college expenses (such as tuition, room and board, and books) are tax free. Depending on the state plan, some 529 accounts also offer other tax benefits, such as state tax breaks and matching grants. You can find the potential value of your state income tax deduction or credit with the College Central State Tax Deduction Calculator. And, you don’t have to use standard 529 funds in your home state-your child can attend college elsewhere. Another type of 529 plan, a prepaid tuition plan, is less flexible but lets you buy credits at participating schools for future enrollment. This type of 529 plan account is only offered in some states and through the Private College 529 Plan for select private schools.

What to be aware of: Money in a 529 plan can only be used for qualified higher education expenses. If you take out money for other purposes (for instance, if your child doesn’t go to college or you need the money for other expenses), you’ll pay income tax and a 10% penalty on earnings. However, if your child doesn’t attend college, you can roll over funds in their 529 plan to a sibling’s plan without penalty. Investment options are limited to those offered by the plan sponsor, similar to employer retirement plans, and the power to make investment changes is restricted.

Coverdell ESAs

Funds in these accounts grow tax-deferred and are tax free when withdrawn for K-12 or college education expenses before age 30. ESAs also offer increased flexibility and are offered by credit unions, banks and brokerages. Investment options are almost limitless, so savers can access mutual funds, stocks and bonds. And, you can make changes at any time.

What to be aware of: Total contributions are limited to $2,000 a year per child, including accounts opened for that child by other family members, such as grandparents. You’ll be subject to the same taxes and penalties as a 529 plan if the funds aren’t used for approved expenses. The ability to contribute is subject to income limits, but children also can put money in on their own behalf.

Investing in the Future

Some parents also choose custodial accounts, taxable investment accounts, retirement accounts, savings bonds and even regular savings accounts to save for college costs. Some college savings options can impact financial aid eligibility, but a financial advisor can help you determine the approach that’s best for you.

Income VS Wealth.