Coverdell vs 529 Plans – Which is the smarter choice?

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In part I of this article series on College Savings Funds, we talked a little bit about the different educational savings account options that are available to parents.  Now, we take a more in-depth look at the Coverdell vs 529 Savings Plans to help you determine what the best choice is for your specific goals with regard to saving for college and not having to rely solely on FAFSA money.

Before you start cashing in savings bonds for college tuition, let’s look at other options…

It’s no secret that the earlier you start saving, the better ROI (return on investment) you’ll acheive.  It’s like that with most long term investments, and educational savings accounts are no exception.  Now, we didn’t hit you with a bunch of  technical, financial mumbo jumbo in the previous article, and we’re not about to start in this one.  Rather, our goal is to enlighten you as to what the major differences bewteen the Coverdell vs 529 are, giving you a better starting point from where you can begin to select a “best fit”.

Coverdell vs. 529 …Let’s Get it ON!!!

Let’s begin our comparison with a look at what the Coverdell Educational Savings Account (or ESA) entails.
Previously known as an “Education IRA”, a Coverdell account is actually quite similar to an IRA (individual retirement account) except that the funds have to be used for qualifying educational expenses.  We’ll get into what qualifies as an educational expense in just a moment.

One thing that Coverdell account offers that the 529 Plan doesn’t is that you have the option to use the funds for education at the elementary, secondary (high school) or college levels.  A 529 Plan is specifically reserved for college and/or post secondary education.  If you choose a Coverdell Account, you are eligible to contribute $2000 per year and nothing more.  You can contribute less if you’d like, but $2000 is the limit at this time.  That lower contribution level is one of the drawbacks of a Coverdell vs 529 Account. 

But wait, before you go off and set up a Coverdell ESA account, you may not qualify!

Who’s Eligible for a Coverdell Account?

Coverdell ESA’s are based off of your Adjusted Gross Income on your tax return.  So, if you have a higher level of income, then you could be left out in the dark.  Below are the income levels that would qualify to open a Coverdell education account…

  •  Adjusted Gross Income: $95,000 – $110,000 (Single Filer)
  •  Adjusted Gross Income: $190,000 – $220,000 (Joint Filer) 

Now let’s turn our focus on the Section 529 College Savings Funds.  Very similar to the Coverdell ESA, a 529 Plan is a fund that’s set up to help save money for college expenses.  These funds can be started as soon as the student or beneficiary obtains a social security number, so very early in life.  Section 529 College Savings Funds are basically mutual funds that are invested into many different companies.  The money grows tax free and fluctuates with the current market conditions. 

Once the fund specifics are set up, the parent or person who’s starting the fund is named as the “Fund Manager” and has all control over…

  • Type of investment (aggressive, moderately aggressive, less aggressive)
  • Monthly/Yearly contributions
  • Withdrawing funds

However, withdrawing money out of a 529 Plan subjects you to penalty in the form of a percentage of that money.  If you plan on starting a 529, make sure you are in it for the long-term to avoid losing any of the money for early withdrawal penalty.

One of the big advantages of the 529 is that once you contribute money, it grows tax free and is not taxed when you withdraw the funds for use on education.  Also, depending on your state, you may qualify for deductions on the contributions you’ve made for that year on your income tax.

Now for the big drawback!  As stated before, 529 plans are tied to the stock market.  So, if the market is doing really well, you could make some significant gains.  If it’s doing…not so good…your 529 could actually start to lose money.  The problem is that no one can predict the market, so starting a 529 college savings fund early in life is the best option.  If you experience a period of “loss”, you have a number of years to make up for it.

Who’s Eligible for a 529 Account?

The great thing about 529 college savings funds is that there are very little restrictions.  As long as the beneficiary has a social security number, they can have a 529 started in their name.  There are no age limits, no contribution limits and no restrictions on how much money you make according to your AGI.

So what qualifies as “Qualified Educational Expenses”?

As outlined in each plan, the money that you save has to be used for educational expenses.  While most parents use the money on the most expensive category..tuition..this is a short list of what qualifies as a qualified educational expenses:

  • Tuition
  • Room/Board
  • Books
  • School Supplies
  • Equipment for Special Needs Students
    *Coverdell allows for a few additional expenses such as transportation and insurance.  See fund details for specifics

Coverdell vs 529 …The Verdict!

The glaring advantage that we see with the 529 is that you can contribute as much, or as little as you would like to the fund.  With the Coverdell, you cannot exceed that $2000 limit which limits it’s return to you.  However, if you plan on using the money before the student turns 18, then the Coverdell is what you want.  While the Coverdell account is great for families that send their kids to private schools and have to pay that tuition, the 529 is generally viewed as a “college” fund and penalizes you if funds are withdrawn prior to the beneficiary turning 18 and going to college. 

As with any situation with regard to education, the choice between these two is purely up to you and your unique situation.  However, if you are looking to start up a college fund for your child who is still in elementary school or younger, a 529 Plan offers more flexibility and potentially a better payout than the Coverdell account.

Get Signed Up With UPromise

We’d also like to mention UPromise as another means of saving for your child’s college tuition.  If you haven’t heard of UPromise, it’s a 100% free way to save money for college by simply using your credit card or grocery card to make everyday purchases.  UPromise automatically takes a percentage of your purchase and places it into an account that can be used for college expenses.  It doesn’t cost you a thing to get set up, so take a minute and get yourself set up…
 Comparing the Coverdell vs 529 plans requires attention to detail.  In your research, make sure you pay close attention to penalties, tax advantages and other factors that are specific to your situation.

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