Paying for Educational Expenses TAX FREE – Comparison of the Coverdell and 529 Plans

With the new school season just around the corner, you have probably already started working on your schools supplies lists. However, the beginning of the year isn’t just the only time you spend money for school. 

Materials for projects, electronics for homework, maybe even school uniforms and tuition are things that come at all times during the school season. Wouldn’t it be nice if the money used for purchases were exempt from federal income taxes? They can be, and there are investment plans that allow you to do this! 

The Coverdell Education Savings Account and 529 are similar education plans that allow you to save for college and other education, but their differences can determine which one is best for you. Some plans, like the Coverdell ESA, allow you to diversify your investment portfolio by doing alternative investments like self-directed real estate or notes, for example. 

In this article, we’ll cover the main differences and similarities so that you can get a feel for which account may best fit your needs.

The Coverdell and the 529 are both used for education, and this is the most common similarity. What does education cover? The good news is… that answer is very broad. Educational expenses can cover everything from school supplies like binders and notebooks, to college textbooks and internet if the school program requires it for the class! 

Another important similarity is that the account holder always maintains control of the distribution of funds, and the taxes grow tax-deferred until distribution. If used for qualified educational expenses, these distributions are completely tax-free! Non-qualified expenses that are withdrawn could be subject to federal tax and 10% penalty. 

What can you use these accounts for:

Their differences are where the two accounts are set apart. Though they are both great accounts that can be used for education, one account allows you to begin using it earlier than the other. 

The Coverdell ESA funds can be used for qualified expenses from pre-k all the way up to college, whereas in the past, the 529 plan funds can be used for qualified college expenses only. With the recent tax reform bill, you’re now able to use $10,000 from a 529 to pay for expenses K-12. This is usually something to consider if one was needing to use the funds sooner rather than later. 

How much can you contribute?

Another difference is the contribution limits. With a 529 plan, the limit varies by state, whereas the Coverdell remains the same across the board (for 2020, it is $2,000 per child, per year until the child reaches age 18). 

One unique characteristic of the Coverdell ESA, is that even though contributions must stop at age 18, the account can remain in that child’s name until age 30 or it can be passed along to another child who qualifies. 

In order to contribute to a Coverdell ESA, the adjusted gross income of the depositor must be less than $100,000 if single, or $220,000 if married and with a 529, there is no restriction.  

It is important to note that gift contributions can be made to a Coverdell. This means that if a contributor had an income over the limit, another person could contribute in his or her place. For example, if a child’s parents made too much, but had grandparents who were under the income limit, they would be able to contribute to the Coverdell if they wanted.

What can you invest in?

The biggest difference is who is in control of the investments. With a Coverdell, the account holder has the option to choose his or her own investment. Oftentimes, Coverdell accounts are seen involved in real estate investments and even private loan partnerships. 

With a 529 account, the state government controls the funds and invests them for you. Deciding whether you want to take control of the account or let the state take care of it will be important when picking which education account is best for you. 

Coverdell ESA and 529 are both beneficial accounts to have for school savings and qualified educational expenses. However, both come with their own freedoms and restrictions. 

It’s up to you to decide how much control you want to have over the account and how you anticipate your future spendings. If you ever want more information about the Coverdell ESA or have questions about which plan might be right for you, call an IRA specialist at 855-FUN-IRAS (855-386-4727).

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