By Wendy Mihm | Tuesday January 25, 2011
If you’re reading this article to help you decide between a 529 vs a Coverdell education savings plan, hooray for you! In my opinion, you’re roughly three-quarters of the way toward investing in your child’s future. My belief is that just investing somewhere – anywhere – is the most important part. Much more important than the way you invest.
Having said that, it’s definitely still worthwhile to research which type of plan fits your family’s financial profile best. Both the 529 plan and the Coverdell Education Savings Plan are ways to set aside money for your child’s education. Both have certain advantages. Depending on your income level and other circumstances, one might be better for your family than the other.
Below are some key attributes of each plan to consider before you choose one. Have a look.
529 College Savings Plan
- College only. Note that the 529 is called a College Savings Plan. That’s because the money you stash away there can only be used for college. (In this context, the term ‘college’ includes both 2-year and 4-year institutions.) That means you cannot use it to pay for private elementary, middle school or high school. The money you put into a 529 plan can be used to pay for typical college expenses, including tuition, room, board, books, etc.
- No income restrictions. Anyone can contribute to a 529 College Savings Plan, regardless of income level or net worth.
- Contribution limits. A 529 College Savings Plan allows for maximum contributions anywhere between $100,000 and $350,000, depending on the state you live in. This limit is considerably higher than the limit set by a Coverdell account, which means you can save a lot more in a given year and over time.
- Guardian controlled. This feature is key for many parents because the money in the 529 plan is controlled by the guardian, which is often the parent. This allows the parents to oversee their child’s education funds and expenses, rather than handing over a relatively large sum of money – and all the decisions that go with it—to such a young adult.
- Tax advantages. Contributions to a 529 College Savings Plan are made with after-tax dollars, but as the funds in the 529 Plan grow, they will not be taxed. Then, when your student enters college and begins spending the money, it will not be taxed at that time either, as long as the money is spent on appropriate college-related expenses. Also, if you live in certain states or the District of Columbia, your contributions to a 529 plan can be deducted from your state taxes. See the FinancialRx article called Top 529 Plans: How To Choose the Best 529 College Savings Plan for a complete list of states that allow state tax deductions for 529 plans.
Coverdell Education Savings Account
- Primary Education or College. Unlike a 529 plan, you can use money in a Coverdell account for private primary school or college. Yes, this includes preschool and kindergarten, along with elementary, middle and high school.
- Investment flexibility. Compared with a 529 plan, you will typically find more options to invest your money in, plus you can reallocate your funds more frequently if you want to. With a Coverdell plan, you can move your money around as many times as you want to, whereas with a 529 Plan you are limited to reallocation once per year.
- Contribution limits. There is a $2,000 annual contribution cap on the Coverdell Education Savings Account. This is something to consider very seriously if your primary goal is to save aggressively for college.
- Income restrictions. The Coverdell Education Savings Account flat out eliminates families over certain income levels from participating, so make note of this requirement immediately. You may not even have a choice to make if you are a high wage- earner. If you are a single parent and and earn over $95,000 per year, you are excluded from the Coverdell. If you are married and jointly earn over $190,000 you cannot participate in the Coverdell plan.
I hope these facts help to clarify the issue of the 529 vs Coverdell in saving for your child’s education. But more importantly, the real take away is not which plan you choose, but that you choose to start saving for your child’s education at all.
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