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Coverdell ESA and 529 College Plan Comparison

Saving for your child’s college degree is a great way to reduce the burden of rapidly rising tuition and education costs. The federal government agrees, which is why it has created a number of tax-advantaged college savings vehicles.

The most popular of these tax-advantaged vehicles are the 529 Plans and the Coverdell Education Savings Account (ESA). Each vehicle has numerous benefits, so how do you pick the right one for you? Here is a side-by-side comparison of some of the most important qualities you might need to consider when choosing your college savings vehicle.

Keep in mind that 529 Plan actually refers to two different types of vehicles — prepaid college tuition plans and college savings plans. For the purposes of this article, 529 will refer only to the college savings vehicle.

Age Limit for Contributions

ESA: The beneficiary must be under that age of 30 in order to make contributions to the account.
529: There are no beneficiary age limits.

Age Limit for Withdrawals

ESA: All funds must be withdrawn and utilized for approved educational expenses by the age of 30.
529: There is no age limit. The beneficiary may utilize the funds over the course of his or her lifetime for approved education expenses.

Maximum Annual Contribution

ESA: A maximum of $2,000 per year per beneficiary may be contributed. If multiple people make contributions, the total still may not exceed $2,000.
529: There is virtually no cap on the level of annual contribution. Allowable lifetime contributions vary by plan, ranging from $100,000 to $365,000.

Income Threshold

ESA: To make the full $2,000 contribution, you must have an Adjusted Gross Income (AGI) of less than $95,000 for single filers and $190,000 for joint filers. The level of contribution phases out for single filers, beginning at $95,000 up to $110,000 ($190,000 to $220,000 for joint filers). Those earning more than $110,000 as a single filer and $220,000 as a joint filer may not contribute to the Coverdell ESA.
529: There are no AGI limits.

Account Ownership

ESA: Ownership of the account remains with the custodians (usually the parents). The beneficiary of the account may be changed at any time.
529: Same as ESA.

Allowable Contributors

ESA: Anyone may contribute to a beneficiary’s ESA, but the total amount of contributions may not exceed $2,000 annually. Multiple ESAs may be opened in a beneficiary’s name, but again, total contributions may not exceed $2,000.
529: Anyone may open or contribute to a 529 Plan.

Tax Benefits

ESA: Contributions are not deductible, but earnings grow free from federal taxes. Withdrawals are also free from federal taxes when utilized for qualified education expenses.
529: Same as ESA. In addition to federal tax benefits, many states also offer deductions for contributions to in-state 529 Plans. Residents of Arizona, Kansas, Maine and Pennsylvania may deduct their contributions (up to a certain threshold) to any state’s 529 Plan.

Qualified Withdrawals

ESA: May be used for any educational expense, from tuition and fees to computers and Internet access, beginning from kindergarten.

If you are planning to send your child to private school, this may be a major advantage of the ESA. The legislation allowing K-12 withdrawals is set to expire in 2010. While Congress is expected to extend the legislation, you should consult with a tax planning professional if this is a major consideration for your family.

529: May be used for education expenses, such as tuition, fees, books, room and board, at any accredited U.S. institution of higher education. Some programs also allow students to use the funds to study at approved foreign institutions.

Impact on Financial Aid Award

ESA: Account is considered the asset of the custodian (typically the parent) and not the beneficiary. Since parental assets are assessed at a lower rate than student assets, the overall impact on financial aid awards is be minimized.
529: Same as 529. Note that if you elect to set up your 529 Plans as a LINK TO: Uniform Gift/Transfer to Minor (UTMA/UGMA) account, the value will be assessed to the student, not the parent.

Investment Options

ESA: Stocks, bonds, mutual funds or CDs, without any limit on the number of changes in asset allocation.
529: Same asset options as ESAs, but can only change investment allocation twice a year.

Still can’t decide which vehicle is best for you? Why not split the difference? Federal regulations allow you to contribute to both ESAs and 529 Plans. If your personal finances allow, consider contributing the maximum $2,000 to an ESA and then topping off your annual contributions in a 529 Plan.


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