Coverdell vs. 529: Ways of Saving for College

Written by Banks Editorial Team
3 min. read
Written by Banks Editorial Team
3 min. read

Are you searching for ways to fund your children’s college education? Both Coverdell Education Savings Accounts (ESAs) and 529 plans are viable options. But which is best? And how do a Coverdell vs. a 529 compare?

In this guide, you’ll learn more about how they work, key similarities and differences, and how to choose the best option for your financial situation. 

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What Is a 529 Plan?

A 529 plan is a state-sponsored plan that allows you to save for your child’s education costs. Contributions are made with post-tax earnings, and you won’t be taxed while the funds accumulate or upon withdrawal if used for qualified education expenses. 

The annual contribution limit is $30,000 for married couples (or $15,000 for singles). Contributions over this amount could be subject to gift tax. Also, note that overall contribution limits are typically between $235,000 and $529,000, depending on your state of residence. 

There are two options to choose from: 

  • Prepaid tuition plan: This plan lets you save money for future tuition costs, but at today’s price. When it’s time for your child to enroll, they will pay the rate that was intact when the plan was opened, which can result in a substantial amount of savings. 
  • Education Savings plan: You’ll get access to more investment options with this plan. They can also be used to cover a broader range of qualified education expenses, like room and board (which is not an allowable expense under prepaid tuition plans).

What Is a Coverdell Education Savings Account (ESA)?

A Coverdell Education Savings Account (ESA) is another tax-advantaged investment vehicle you can leverage to save for your child’s college education. You can make up to $2,000 in post-tax contributions annually. The funds can be used on qualifying educational expenses, like tuition, books, fees, room and board. Furthermore, they are not subject to taxation upon withdrawal.

Is a Coverdell ESA the Same as a 529 Plan?

They’re both used for the same purpose, but aren’t quite the same. Below is a breakdown of the key similarities and differences. 

Similarities of a Coverdell ESA vs. a 529 Plan

  • Both offer tax-free growth and withdrawals for qualifying expenses.
  • You have to name the child as a beneficiary for both plans. 
  • Funds in both plans are transferable to a relative of the beneficiary without forfeiting tax benefits. 
  • Neither will hurt your child’s chance of receiving financial aid since colleges and universities exclude them from the asset calculations. 

Key Differences Between Coverdell ESA vs. 529 Plan

  • Coverdell ESAs offer more investment options than 529 plans. 
  • The contribution limits for 529 plans are more generous. 
  • You must meet income requirements to contribute to Coverdell ESAs.
  • There’s more flexibility with how funds can be used with Coverdell ESAs. 
  • The donor controls the funds with 529 plans, while Coverdell ESAs require funds to be transferred to a relative of the beneficiary if unused when they reach the age of 30. 

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Advantages and Disadvantages of a 529 Plan and Coverdell ESA

Now that you understand how these plans are similar and different, here’s an overview of the benefits and drawbacks

Pros of a 529 College Savings Plan

  • Tax-free growth and withdrawals
  • Funds can be used for both college and K-12 tuition and fees
  • No income restrictions 
  • No age restrictions 
  • Lock in today’s cost of tuition for the future
  • Generous annual contribution limits 
  • Transferable to relatives 

Cons of a 529 College Savings Plan

  • Limited investment options as the plan is controlled by the state 
  • Beneficiary must reside in the state where the prepaid tuition plan is sponsored
  • 10% penalty and federal income tax if used improperly 

Pros of a Coverdell ESAs

  • Tax-free growth and withdrawals
  • Flexible investment options
  • Transferable to relatives 

Cons of a Coverdell ESAs 

  • Low annual contribution limits
  • Must be used or transferred to a relative of the beneficiary by 30
  • Income restrictions to contribute to a plan 
  • 10% penalty and federal income tax if used improperly 

Coverdell ESAs vs. 529: Which Is Right for You? 

A Coverdell ESA is best if you’re an early planner with multiple children, as you’ll have an ample amount of time to make contributions and meet your savings goals. It’s also ideal if you prefer flexible investment options that aren’t available with prepaid tuition plans. 

However, a 529 plan is a better fit if you’re a high earner that doesn’t qualify for a Coverdell ESA. While the investment options could be a bit restrictive, the upside is you could save a bundle on rising tuition costs in the future by locking in today’s rates with a prepaid tuition plan.

Now that you know how a Coverdell vs. a 529 plan compares, and you learn about a more flexible alternative way for saving, give your child a gift that could serve them well for years to come.

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