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Coverdell ESA vs 529 College Savings Plan – Differences & Comparison

Planning for college education expenses early — as in from birth — lets parents spread out the cost and contribute to a child’s higher education without the huge burden posed by an annual tuition bill.

Sending a student to college comes with major expenses, and not all parents can or should pick up the tab for their children. If you do, choose a wise place to put your savings to make sure you get the most out of your money.

Like it does for retirement savers, the IRS offers tax advantages for college savings and expenses through savings accounts, bonds, and tax credits and deductions. If you want to contribute to an education fund for your child, grandchild, or a sibling’s or friend’s child, a tax-advantaged 529 college savings plan through a company like CollegeBacker or a Coverdell Education Savings Account (ESA) are the first options to consider.

What Is a 529 College Savings Plan?

529 Plan College Education Savings Plan

A 529 Plan is an investment account designed to pay for college. The name comes from the section of the IRS code that authorizes its tax advantages, which vary by state but generally offer these benefits:

  • Contributions are tax-deductible at the state level, and earnings are deductible on federal taxes.
  • A student can use the plan’s funds to pay for college without paying taxes for receiving them.

A 529 plan can be set up a few ways:

  • College Savings Plan. Use the funds to pay for education at a private or public institution in any state.
  • Prepaid Tuition Plan. Make fixed payments to lock in current tuition rates for in-state public schools (A word of caution: Rates aren’t guaranteed in all states, so make sure you understand what happens if the plan is underfunded in your state).
  • Private College 529 Plan. Prepay for a participating private school to lock in current tuition rates.

Anyone can start a 529 college savings account for any future student, including parents, grandparents, parents’ siblings, and friends. The account can be in anyone’s name, but it’s typically in the student’s or a parent’s.

You can only contribute the amount necessary to pay for qualified education expenses for the student, which is determined by state.

A student can withdraw from the 529 account any time, and they won’t pay taxes on the distribution as long as they use the funds for qualifying education-related expenses. The student can receive funds directly or have them paid to the school.

Qualifying expenses for a 529 plan include:

  • Tuition and fees
  • Required books, supplies, and equipment
  • Room and board
  • Computer, software, and Internet access used for school
  • Fees, supplies, and equipment for an apprenticeship program
  • Up to $10,000 in student loan repayment

A 529 plan can pay for postsecondary education or up to $10,000 of K-12 education.

Personal expenses, including insurance, medical expenses, and transportation don’t qualify.

Pros

  1. You can deduct contributions on most state taxes, and investment earnings on federal and most state taxes.
  2. Anyone can contribute to and benefit from the account, without income limits.
  3. Your contributions grow over time because it’s an investment account.
  4. The contribution limits — the amount you can deduct from state taxes — vary by state but are typically higher than those for an ESA.
  5. Students can use the funds at any age.
  6. You can keep the plan in your name even as a student uses it to pay for school, so you always have control over the funds.

Cons

  1. Qualified expenses are limited to tuition, fees, and related expenses, such as books.
  2. States don’t guarantee tuition rates for prepaid plans.
  3. As an investment, returns aren’t guaranteed, and your money is subject to market risk.

Who Should Open a 529 Plan?

A 529 college savings plan is a smart investment in your child’s education at any point in their life. Compared with an ESA, it’s a better option if you begin saving later in the child’s life because you can save more each year to reach a higher balance before the recipient starts college and can continue saving while they’re in school.

You can contribute to both a 529 plan and an ESA for the same child. The benefits are similar, but an ESA has more limits, so it makes the most sense to open a 529 first.

You can keep control of a 529 plan even as a student withdraws from it, so if you don’t want to turn the account over entirely to the student, choose a 529 over an ESA.

Also choose a 529 if you don’t expect or don’t know whether the beneficiary will finish school before age 30, or if you expect them to enroll in an apprenticeship program, which ESA funds don’t cover.

If 529 plan contributions are tax-deductible in your state, this plan has an additional advantage over an ESA.

A 529 plan is usually the best option for high-income families. You can’t contribute to an ESA if you earn more than $110,000 per year or if you and your spouse combined earn more than $220,000 per year, but a 529 plan has no income cap.


What Is an ESA?

Esa Education Saving Account

Formally called a Coverdell Education Savings Account, an ESA is an investment account designed to save for college that functions similarly to a Roth IRA.

Anyone can contribute to an ESA for any future student, as long as your adjusted gross income (AGI) is less than $110,000 ($220,000 for married couples filing jointly). Contributions are not tax-deductible, and the limit on contributions toward any beneficiary is $2,000 per year.

Students can withdraw funds any time before age 30 and pay no taxes on distributions as long as they use them to pay for qualified education expenses.

Qualifying expenses for an ESA include:

  • Tuition and fees
  • Required books, supplies, and equipment
  • Room and board
  • Computer, software, and Internet access used for school

An ESA can pay for postsecondary education or up to $10,000 of K-12 education.

Except for special-needs students, any money left in the account when a beneficiary turns 30 is distributed and taxed as income.

Pros

  1. Your contributions grow over time because it’s an investment account.
  2. The invested funds grow tax-free. You pay no federal tax on the interest earned.
  3. Distributions are tax-free as long as a student uses them to pay for qualifying education expenses.

Cons

  1. Contributors must earn less than $110,000 per year.
  2. You can only contribute up to $2,000 per year per student.
  3. Contributions are not tax-deductible.
  4. Students must use the funds before age 30 to receive the tax benefit.
  5. You can’t contribute to an ESA after the beneficiary turns 18.
  6. You can’t use an ESA to pay for an apprenticeship or student loans.
  7. As an investment, returns aren’t guaranteed, and your money is subject to market risk.

Who Should Open an ESA?

It makes the most sense to open a 529 first, but you can also open an ESA if you meet the income requirements and want to contribute beyond the 529 limit in your state.

You can only contribute to an ESA if you earn less than $110,000 per year ($220,000 for married couples filing jointly), so this isn’t an option if your income is higher.

The contribution limit for an ESA is $2,000 per year per beneficiary, so opening an account and saving early in a child’s life makes it easier to grow the balance high enough to pay for their education by the time they start school.

Because you can’t contribute after the child is 18 and the money is automatically distributed when they turn 30, an ESA is a better option if you prefer to turn the account over to the child as they grow older.


ESA vs. 529

The main differences between an ESA and a 529 plan are:

  • Income Limit. You can only contribute to an ESA if your AGI is less than $110,000 per year ($220,000 for married couples filing jointly), but a 529 plan has no income limit.
  • Contribution Limit. The ESA contribution limit is $2,000 per year, and the 529 limit varies by state, but is generally higher — often up to the total cost of education.
  • Age Limits. You can’t contribute to an ESA after the beneficiary turns 18, and they can only receive the tax benefit on distributions until age 30. A 529 plan has no age restrictions.
  • Tuition Rate. A 529 lets you lock in a current in-state tuition rate, which an ESA does not do.

Before 2018, you could use ESA funds — but not 529 funds — to pay for K-12 private school, which gave ESAs a huge advantage for some families. The Tax Cuts and Jobs Act changed that, so families can now use either savings plan to pay for those expenses.


Final Word

A 529 college savings plan and a Coverdell ESA are similar investment vehicles designed to encourage long-term savings for a child’s education.

You can open both for a single beneficiary and contribute to them concurrently. A 529 plan has fewer restrictions and slightly broader application, so it’s likely the best place to start for most families. A financial adviser can tell you which investment options are best for your situation.

If your child’s expected education expenses exceed the combined contribution limits of these plans, consider other creative ways to save and invest for college, including Roth IRAs, permanent life insurance, and fixed annuities.

Are you considering opening an ESA or 529 college savings plan? Which one are you leaning toward and why?

Dana Sitar
Dana Sitar has been writing and editing since 2011, covering personal finance, careers and digital media. Say hi and follow her on Twitter @danasitar.

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