Coverdell ESA vs. 529 Plan Comparison Chart

I’ve been doing some research into college savings plans, and here is a side-by-side comparison of the Coverdell Education Savings Account (ESA) and the 529 College Savings Plan. The Coverdell used to be known as an “Education IRA” and still functions similar to a Roth IRA for qualified educational expenses. However, 529 plans also offer tax-free growth and seem to be much more popular these days. Each plan has its own set of strengths and weaknesses.

Coverdell ESA 529 Account
Federal Tax Advantages Earnings grow tax-deferred and withdrawals are federal income tax-free when used for qualified education expenses.
(tie)
Earnings grow tax-deferred and withdrawals are federal income tax-free when used for qualified education expenses.
(tie)
State-Tax Deduction for Contributions No. Possible, state-specific.
winner
Qualified Expenses Qualified elementary, secondary, and college education expenses.
winner
Qualified college expenses only
Contribution Limits $2,000 annually for 2012. After that, it reverts to $500 annually unless extended again by Congress. Technically, the limit is the “anticipated cost of a beneficiary’s qualified education expenses”. This results in state-specific total limits of ~$200,000 or more.
winner
Income Limitations Contributions are phased out for married filing jointly with MAGI $190,000 to $220,000; single filers MAGI $95,000-$110,000. (2012) None.
winner
Investment Flexibility Open at broker of your choice and invest in any bank deposit, mutual fund, or individual stocks and bonds. Buy/sell as you like.
winner
Limited to the selection provided by each state-specific plan. Investment changes only allowed twice a year.
Beneficiary Limitations Can change beneficiary. Beneficiary must be under 18 during contribution phase, and the funds must be withdrawn by age 30. Can change beneficiary. No age restrictions.
winner
Financial Aid Treatment A parent-owned Coverdell ESA is reported as a parent asset on FAFSA. If owned by grandparent, it is not included in FAFSA.
(tie)
A parent-owned 529 Plan is reported as a parent asset on the FAFSA. If owned by grandparent, it is not included in FAFSA.
(tie)

In general, the Coverdell ESA appears to be the better choice if you want to pay for Kindergarten through 12th-grade expenses (includes private school tuition, fees, books, computers, and internet access for the student). However, the contribution limits are somewhat low and phased out completely if your income is high enough. I do like the ability of picking your own broker and investments, for example you can probably find (slightly) lower-cost index funds or ETFs than those available in state-run plans.

The 529 plan is certainly more popular nowadays due to its combination of tax benefits and relatively low restrictions. There are no income limits, no age limits, and most people won’t get anywhere near the ~$200,000+ total contribution limits (although not a limit, note that gift taxes may apply if you exceed the $13,000 annual gift exclusion). Many states now offer a state income tax deduction for 529 plan contributions, providing an upfront incentive for saving.

If you wish, you can also contribute to both a Coverdell ESA and a 529 plan in the same year for the same beneficiary.

Comments

  1. I think that the 529 plan is state tax deductible, depending on the plan and which state you’re in. At least it is tax deductible in Illinois.

    Otherwise, great chart!

  2. The Missouri MOST (529) plan provides for a reduction by the amount of the contribution to income on the Missouri tax form, effectively giving a tax break. It’s not a tax credit, since it’s not refundable if you end up owing “less than zero” tax for the year.

  3. First Step says:

    Some contributions to a 529 plan are also deductible in NC. For a single filer, the maximum deduction is $2,500; for a married couple, the maximum is $5,000. Contributions to a Coverdell aren’t deductible at this time.

  4. I have both splitting even for my son and another good thing about coverdall is you can also move the money to 529 if you choose and not used.

  5. Ohio’s 529 is state tax deductible up to $2000 per year.

  6. Does anyone know if there are time limits with regard to getting the state tax deduction, i.e., if I contribute $10k to NY’s plan now and withdraw in early Sept for tuition, are my effective savings still “state income tax rate” x “$10k?”

  7. Not all 529 plans are state ran, which is what your article seems to indicate. In Florida we don’t have a state tax, which you just open up a 529 plan with vanguard, fidelity or where ever. So the investment choices are better than the article indicates.

  8. Jason D says:

    Another benefit for the Coverdell is that there are no management fees on the investments.

  9. I get a state tax deduction for my state’s 529 plan as well.

  10. In MD we get a state income tax deduction of contributions up to $2500 per account owner (so $5k if you and your spouse each have one) per beneficiary if we contribute to our state’s 529 plan.

    I wonder if anyone has made contributions to their state plan for the deduction and then later (or sooner) transferred them out into another state’s 529 that offers lower cost passive investment options (like Vanguard).

    To me the more important question is how much people are contributing. We have two kids now and college is probably as big a future liability as our mortgage at this point.

    Seems like a good strategy, given the income contribution limits, might be to fund the 529 as parents and have the grandparents set up a Coverdell after they retire, assuming they then fall under the income phase out.

  11. Does Vanguard has Coverdell Education Savings Account (ESA) ? I mean where can I open an account

  12. I’m looking forward to your chart on the best state to set up a 529 plan in. As I recall, I had it narrowed down to Utah or Nevada.

  13. Michael says:

    SC has unlimited state tax deduction on 529 contributions, which is nice – I lump funded 529′s for both of my daughters earlier this year and essentially got 7% back in a refund from the state.

    Also, although the $13k gift tax does apply to 529 contributions, you can lump fund up to 5 years for a husband and a wife, so that’s $130k total in 1 year that you can contribute for a married couple – though if you did that, you wouldn’t be able to contribute anything for the next 5 years without gift tax implications.

    If you’re a high income tax state, 529′s can be a great deal.

  14. Here is how to get around the ESA contribution phase-out:

    http://www.fairmark.com/colleg.....ontrib.htm

    Read the “Avoiding the Income Limitation” section.

  15. ParatrooperJJ says:

    I’ve been told the grandparent loophole on 529 plan ownership has been closed as of 2010 but I don’t have a specific citation.

  16. Jenna, Adaptu Community Manager says:

    Thanks for the comparison!

  17. I have both, 529 for the older kid and a Coverdell for the younger kid. I initially chose the 529 because of the tax benefits, then later went with the Coverdell because it was not subject to being run by whatever company managed to woo the state officials. The 529s I’ve looked at, and the one I’m actually in, suffer from a lack of good investment options. The Coverdell is like a 401k in that I can have it at whatever broker I like and run my own investment plan. There are no tax benefits on the contributions to the 529, but the difference in performance I’m getting far outweighs it. With the same annual contributions, the younger kid’s fund is already well ahead of the older kid’s fund (using a simple, dividend focused strategy I might add). I think of the 529 as having an internal tax, one that the plan managers levy.

  18. The State-Tax Deduction for Contributions was initially switched between Coverdell and 529. There are no state deductions for contributions to Coverdells.

    Here is a list of state tax deductions or tax credits by state: savingforcollege.com

  19. @JR – Vanguard no longer offers a Coverdell ESA for new applicants. They used to offer them and still service the old ones. I’m compiling a list of Coverdell brokers.

    @jbo – Can you share a 529 plan that is not sponsored by a state? It’s my understanding that you can open up a plan at another other state’s 529, and the ones at Vanguard, Fidelity, etc are all affiliated with a state and have a layer of management fees that make them more expensive.

    @whytax – Very interesting, I hadn’t thought about having the child make the contribution.

    @ParatrooperJJ – Here’s more about the “grandparent loophole” and how it’s changed but still exists to a smaller extent.

  20. question: can we invest/contribute both every year? if yes, is there a combined contribution limit? (in NY state, 529 has an annual limit of $5K.)

  21. @Andy – Yes, up to each account’s individual limits. The $5k limit for NY is only for state tax deduction for 529. You can contribute up to a total balance of $375,000 for NY state.

  22. Love your blog. Each person should investigate their state’s rules for 529 tax write-offs. We live in AZ, yet contribute to Utah’s Educational Savings Plan (consistently top-rated). We receive a AZ state tax deduction even though we contribute to a different state’s plan. This wasn’t how AZ originally set-up their deductions for 529 plans, but they have since changed it (and probably will yet again).

  23. Nancy Farmer, President of Tuition Plan Consortium, LLC says:

    I am President of a Consortium of over 270 private colleges and universities that voluntarily sponsor a prepaid tuition plan, Private College 529 Plan. We created http://www.tomorrowtuitiontoday.org for families to learn more about saving/prepaying for college. 529 plans offer tax incentives, but sadly, too few families and future students are even aware of them. We would love to link to your chart on our site as a resource guide for families.

  24. Good comparison, but what is the final? Example, Every year I put $2000 for each: ESA and 529. After 10 years what $ will be mine savings? How much I will have in my account: ESA and 529? If I count state Tax detectable? I think final found is important for comparison. Can some body who already used or uses it answer my questions? Thank you.

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