If you’ve just had a child, then it’s never too early to start thinking about their future. Sending a child to college is a huge expense, and many parents are unable to fund their children’s college expenses. By the way, it doesn’t make you a bad parent if you don’t pick up the tab for your child’s college expenses. However, if you plan early, you can help change your family tree by helping your child stay out of debt early in their life. The two most popular college savings accounts are the Coverdell Educational Savings Account (ESA) and the 529 college savings plan. Both of these savings plans act much like an Health Savings Account or retirement account, because they are invested in investments such as mutual funds and withdrawals must be used for a specific purpose or at a specific time in one’s life. I’ll give you the pros and the cons for each savings plan, and you can decide which plan will work best for you.
Educational Savings Plan
- The invested funds grow tax-free. You are not required to pay taxes on the interest earned.
- It has a broad definition for “qualified expenses”. Along with tuition, room, and board, it covers items like books, computers, and internet access.
- the funds can be used starting when the child is in Kindergarten. This is great for someone looking to use the funds to cover private elementary and secondary schooling.
- Contributions are used with after-tax dollars, but the distributions are tax-free as long as it is used for qualified educational expenses.
- You must make less than $220,000 a year per married coupleo to be able to contribute to an ESA
- An ESA only allows you to contribute up to $2,000 per year
- Contributions are not tax-deductible
- Beneficiary must be under the age of 30
- In some states, the assets of the ESA become the property of the beneficiary
- The limit for contributions is much higher and allows you to save more aggressively
- No age limit for the beneficiary
- Control of the account always stays with the contributor
- Some states allow 529 plan contributions to be deducted on state taxes
- Anyone with any salary can open and contribute to a 529 plan
- Qualified expenses are limited to tuition, room, board, and books
- The distributions can only be used for post-secondary schooling
- You are locked into the investments chosen by the plan administrator
Who should open an ESA?
If you are thinking about sending your child to private school and you want more flexibility with how the funds are invested, I think the ESA is your best option. As long as you meet the income requirements, this would be the way to go. Plus, you can use the money to expensive items such as books, computers, graphing calculators, and other expensive items that college requires.
Who should open a 529 plan?
If you are starting out saving for your child’s college expenses later on in their life, then you should definitely open a 529 plan. You’ll be able to aggressively invest and catch up for the years you missed. Plus, if you live in a state where the contributions are tax deductible for your state taxes, you should look into a 529 plan over an ESA.