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What is the difference between a 529 and a Coverdell education savings account?

Today’s question comes from someone looking to put assets aside to save for their child’s college expenses.

The question is:

“What is the difference between a 529 and a Coverdell education savings account? When is one better than the other?”

Transcript:

There were a few key differences between a Coverdell, also known as an ESA or education savings account, and a 529 that were recently changed with the new tax law. So, know that things that you have heard a couple years ago may not be right anymore.

529 and Coverdells offer tax free growth of savings if the money in the accounts is used towards qualified higher education expenses, or private secondary school tuition. Think of it like an IRA or 401k, but for your child’s college expenses or private school tuition.

Which one is best for you will largely depend on the state that you live in, how much you are able to save, and the age of your child.

First, most states offer income tax deductions to save in a 529. Those of you in every state that has an income tax except California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota, New Jersey, North Carolina and Tennessee can get a tax break for using a 529.

Contributions to Coverdells do not provide any income tax deductions. So for many, that is a huge benefit for 529s over coverdells.

Coverdells also have relatively small annual contribution limits. You can only contribute $2,000 per year into a Coverdell account, where a 529 account is effectively unlimited.

Lastly Coverdells can not be funded after the student turns 18, whereas 529s can be funded throughout the student’s time in college.

But Coverdells can give you added investment flexibility. Unlike a 529 where your investment options are limited, coverdells can be used to invest in just about anything you want, including individual stocks.

So, for most, 529s are a better way to save for college, the exception is for those of you with less than $2,000 per year to save in states that provide no tax incentives to use 529s.

Matt Hylland