With the skyrocketing costs of college tuition, saving early for your child’s education is more important than ever. Two popular education savings vehicles are Coverdell Education Savings Accounts (also known as Coverdell ESAs or CESAs) and 529 plans. While both allow you to invest money for education tax-free, there are some key differences between the two.
Here’s an overview of how Coverdell ESAs and 529 plans compare.
What is a Coverdell ESA?
A Coverdell ESA is an investment account that allows you to save up to $2,000 per year for a child’s K-12 and college education expenses. Contributions grow tax-deferred, and withdrawals are tax-free if used for qualified education expenses. Some key features of CESAs include:
- Funds can be used for elementary, secondary, and college expenses. This allows flexibility if your child does not end up attending college.
- There are income limits of $110,000 for individuals and $220,000 for married couples contributing to a Coverdell ESA.
- You have flexibility in how you invest ESA funds. You can invest in stocks, bonds, and mutual funds, and even alternative investments if you open an account with a directed custodian such as Equity Trust.
- Funds must be used by age 30. Any unused funds left after age 30 would be subject to taxes and penalties unless transferred to an ESA in the name of a qualified family member.
What is a 529 plan?
529 plans are specifically intended for college savings. They allow you to invest after-tax contributions that grow tax-free. Some key features of 529 plans include:
- Funds can only be used for college expenses. They cannot be used for K-12 costs.
- There are no income limits for contributing. Anyone can open and contribute to a 529 account.
- Most plans offer mainly investment portfolios aligned to a beneficiary’s age. There are limited individual investment options.
- Funds do not have to be used by a certain age. Leftover funds can be transferred to another beneficiary.
Key differences between a Coverdell and a 529
- Coverdell ESAs allow savings for K-12 while 529 plans are just for college.
- Coverdell ESAs have income limits while 529 plans do not.
- You have more investment options with Coverdell ESAs compared to 529s.
- Unused Coverdell and 529 funds can be transferred to certain family members
- Coverdell funds must be used or transferred by age 30, while there is no age requirement with a 529.
- Annual contribution limits are lower for Coverdell ESAs at $2,000 vs. $10,000 or more for some 529 plans.
Stretching a CESA’s investing power even further
As mentioned above, if a CESA is opened through a directed account custodian, it can be used to invest in a range of options in addition to stocks and mutual funds. Investments for a self-directed CESA can include real estate, land, private equity, private lending, and much more, similar to self-directed IRAs and other accounts.
Wondering how to use a Coverdell ESA with a small balance to invest in alternatives such as land or real estate? Read how Equity Trust client Brian partnered his children’s education savings accounts for two land purchases, which grew their balances quickly.
[Case Study] 2 Investments Earn $130,000 in Profits to Help Boost 5 Self-Directed Accounts
