1. Coverdell Education Savings Account: Introduction
  2. Coverdell Education Savings Account: Who’s Eligible to Contribute?
  3. Coverdell Education Savings Account: Opening an ESA
  4. Coverdell Education Savings Account: Avoiding Taxes on Distributions
  5. Coverdell Education Savings Account vs. 529 Plan
  6. Coverdell Education Savings Account: Conclusion

If you’re looking for college savings options, a 529 plan is one alternative to consider. These plans can be administered by the state or by an educational institution, and they also offer a tax-advantaged way to save. How do these plans compare to Coverdel ESAs?

529 Plan Basics

There are a number of significant differences between the two types of plans.

What they cover. A 529 plan is a savings plan that’s designed specifically for higher education expenses, unlike an ESA which can be used for elementary or high school education costs. Like an ESA, the distributions from a 529 plan are tax-free when used for qualified education expenses at an eligible school and the contributions are not tax-deductible.

Who can contribute. Anyone can set up and contribute to a 529 plan, regardless of their income. That’s a significant advantage over ESAs. You don’t have to be a resident of a particular state to contribute to its plan, and you can establish more than one 529 plan for the same beneficiary. The beneficiary can be your child or another family member, including your spouse. You can also set up a 529 plan for yourself if you plan to go back to school.

How much you can contribute. Higher contribution limits are another plus of 529 plans. While the IRS sets the annual contribution limit for ESAs, the limit for 529 plans works differently. The total amount contributed over the child’s lifetime can’t exceed the total cost of their qualified education expenses. This limit can vary, based on the average cost of attendance in each state.

In terms of an annual contribution limit, you can contribute up to $14,000 to one child’s 529 plan without triggering the gift tax. That amount is doubled for married couples filing a joint return. The gift tax rule applies to the person making contributions, not the person receiving them. So, if you’re married with two kids, you and your spouse could contribute $28,000 to each of their 529 plans on their behalf and their grandparents could also chip in $14,000 or $28,000 per child, depending on their tax-filing status.

The IRS also allows you to front-load contributions to a 529 plan by making five years’ worth of contributions at once. You can’t make any additional contributions during the following five-year period, but this may be a useful estate-planning tool for grandparents who are hoping to create a tax shelter.It also lets the plan start benefiting from tax-free growth generated by compound interest on the largest possible sum.

Deadline for taking distributions. One final key difference between 529 plans and Coverdell accounts is the deadline for taking distributions. Unlike an ESA, you can leave funds in a 529 account until they’re needed; there’s no penalty for waiting until your 30s to take distributions. But, the beneficiary will pay taxes on earnings, plus the 10% penalty for any distributions not related to qualified education expenses. That’s a significant difference, since the beneficiary is responsible for paying the tax on non-qualified distributions from a Coverdell ESA.

Can You Contribute to Both an ESA and a 529 Plan?

The simple answer is yes, if you meet the MAGI guidelines for a Coverdell ESA. The real question is, should you?

The answer ultimately depends on how much you’re able to save and how much you need to save to cover education costs. If you can’t fund both accounts, funding a Coverdell ESA might be sufficient. If, on the other hand, you can afford to make contributions to both accounts and you have a large savings goal you’re working towards, then it might make sense to do so. Remember that if you’re contributing to both accounts, you’ll need to make sure you’re only withdrawing enough from each one annually to cover qualified expenses to avoid a tax penalty.


Coverdell Education Savings Account: Conclusion
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