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The Best Way to Save for College: Coverdell ESA

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Last week, we launched a new series here about the best vehicles for saving for college. The first two posts covered 529 Plans, both College Savings Plans and Prepaid Tuition Plans.

If you didn’t catch them last week, start there.

Today we are looking at a lesser known college savings vehicle: the Coverdell Educational Savings Account, also referred to as the Educational IRA. Once the way to save for college, the ESA fell out of favor in 2002 when the 529 Plan came to the fore. The ESA still has a lot of advantages, however, and you should definitely consider it when making your college savings plan.

What is it: An Education IRA — like the Roth IRA, but for college instead of retirement. Allows you to invest up to $2,000 per year per child with tax-free earnings and withdrawals.

Pros: Earnings and qualified withdrawals are tax-free; funds may be used for educational expenses in K-12, as well as for higher education; beneficiary of account can be transferred up to age 30

Cons: Contribution is limited to $2,000 per year per beneficiary; income limits for depositing funds; age limits for withdrawing funds; account is considered parental asset on FAFSA, so it doesn’t have overly negative impact on financial aid award

Bottom Line: A good choice for those of you with private school tuition for your little ones, but otherwise less attractive than the 529 College Savings Plan.

Want to know more? We recently updated the Financial Aid Finders section on Saving for College with an in depth review of the Coverdell ESA. If you are not sure whether to go with the ESA vs. the 529 Plan, check out this comparison between the two. And remember, there’s no law against investing in both of them!

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