529 Savings Plan Versus Coverdell ESA

You Have Three Options in Total

529 College Savings plans and Coverdell Education Savings Accounts (ESAs) are two of the most popular tax-advantageous ways to save money for future education expenses. Because there are two types of 529 plans, the 529 College Savings Plan and the 529 Prepaid Tuition Plan, we will compare the advantages and disadvantages of all three types.

Please note that the rules and regulations for all savings plans are complex and contain many exceptions that cannot be covered here. We will address the highlights and encourage you to seek professional assistance from an independent financial advisor to make the most informed decisions for your specific needs.

The Benefits of a Coverdell ESA

• You have the most investment options and flexibility, operating similar to a self-directed IRA.
• An ESA is the only education savings plan that covers qualifying elementary and secondary educational institutions (Kindergarden through 12th grade).
• You can later transfer Coverdell ESA assets into a 529 Plan, but not the other way around.
• Covers more qualified expenses than a 529 Prepaid Tuition Plan.

Disadvantages of a Coverdell ESA

• Much lower contribution limits, not to exceed $2,000 per year per beneficiary.
• Contributors must meet income eligibility requirements, whereas contributors to either 529 plan do not.
• Contributions can no longer be made once the beneficiary reaches the age of 18.
• Disbursements for qualifying education expenses can no longer be made once the beneficiary reaches the age of 30. Unused funds must be distributed and are penalized and taxed (unless the beneficiary is able to transfer the funds to a qualifying family member under the age of 30).
• Unlike 529 plans, where control of the account stays with the account owner, control of the ESA account transfers to the beneficiary at the age of 18. Unused funds are distributed to the beneficiary.

The Benefits of a 529 Prepaid Tuition Plan

• Excellent for risk-averse investors, since educational benefits are received as long as the specified contributions have been made.
• There is comfort in knowing that all tuition has been paid and does not depend on the performance of investment markets.
• In some cases, states offer guarantees in the event the educational institution cannot meet its obligations.
• Much higher contribution amounts than the Coverdell ESA.
• Some states allow for partial or complete tax deductibility of contributions.
• In most states, control of the account remains with the contributor.

Disadvantages of a 529 Prepaid Tuition Plan

• Covers fewer education expense than either the Coverdell ESA or 529 Savings Plan, usually limited to tuition and mandatory fees. Some schools offer a room and board option.
• Not available for elementary and secondary education expenses.
• Choice of schools can be severely limited.
• A prepaid plan may not be offered by the school the student wants to attend.
• Not an appropriate plan for those who want to have some control over how savings is invested.
• In some states, age restrictions apply that aren’t applicable to the 529 Savings Plan beneficiary.

The Benefits of a 529 College Savings Plan

• The largest contribution limits of all plans.
• No income requirements to be an eligible contributor.
• Contributions can be made at any time and regardless of the age of the beneficiary.
• Qualifying educational expenses can be paid for students of any age, well beyond the age 30 limitation of the Coverdell ESA.
• Some states allow for partial or complete tax deductibility of contributions.
• Largest selection available of colleges and universities.
• Excess or unused funds can stay in the account. There are no forced distributions as there are with the Coverdell ESA.
• In most states, control of the account remains with the contributor.
• Covers more educational expenses than the 529 Prepaid Tuition Plan, and about the same as those covered by the Coverdell ESA.
• Though there is less individual control over investments as there is with Coverdell ESAs, investments are professionally managed.

Disadvantages of a 529 College Savings Plan

• Investment options are more limited than those available to the Coverdell ESA.
• Changes to the investment option can be made only twice per year.
• Not available for elementary and secondary education expenses.

You Can Contribute to All Three Accounts

Fortunately, for those struggling to decide which account to open, it is possible to have all three account types for the same beneficiary. Why might someone do this?

For starters, a Coverdell ESA is the only account type that can be used for elementary and secondary education expenses. If ESA assets weren’t used for elementary or secondary education, they can simply be transferred into a 529 Savings Plan. One or both of the 529 plans could then be used for college expenses.

Another example might occur when someone wants to use a 529 Prepaid Tuition plan to know for certain that tuition has been paid, but also plans on paying for room and board and other educational expenses that qualify under the ESA and 529 Savings Plans, but not under the 529 Prepaid Tuition Plan.

As always, we strongly recommend that you speak with an experienced financial planner who understands not only the education savings plans, but can consider how investing in these plans fits within the bigger financial picture of those involved.

Related Articles

What is a 529 Plan?
What is a Coverdell ESA?

About the Author

Todd E. Frank, CPA/PFS, MBA is the President and CEO of Frank Financial Advisors, a Registered Investment Advisory Firm (RIA) serving clients nationwide from our headquarters in Carlsbad, San Diego, California. As an RIA, Frank Financial Advisors is able to offer truly independent, fee-only financial advisory services.