Saving for College? Consider the Coverdell
By David Dierking
The name “529” has become synonymous with college saving since the account was created back in 2001. It’s become so synonymous that many people will likely assume that the 529 is the only account out there geared specifically towards saving for college. Not only is it not the only college savings account out there it might not even be the best option out there.
The Coverdell Education Savings account began its life as the Education IRA account before getting named after the late U.S. Senator Paul Coverdell who was its primary advocate. The account provides for tax-free savings for education just like the 529 but with some important differences as well.
Here, I compare and contrast the two accounts and which I think might be a better deal.
The biggest difference in the two account types is how much you can put into them. How much you can put into a 529 account depends on the state that the account is opened under but in general the contribution limits range from about $100,000 to as much as $350,000 per beneficiary. That means for the average American there’s essentially no limit.
With the Coverdell, you are limited to a $2,000 annual contribution from all sources. Additionally, you must meet IRS income limit requirements in order to contribute to the account at all.
Advantage: 529 – With greater contribution limits and no income restrictions, the 529 offers much more flexibility.
Uses For Plan Assets
529 plans allow for tax-free withdrawals for college expenses only.
Coverdell accounts allow you to save for qualified expenses from elementary school all the way through to college. This is particularly advantageous to someone who has children in private school and is looking for additional tax savings.
Advantage: Coverdell – Being able to save for elementary, high school or college tuition gives the Coverdell account the edge.
Generally speaking, just about anyone can contribute to a 529 account. There is no income limit restriction on individuals who contribute to the 529 account so the wealthy can take advantage of these accounts just like everybody else.
With the Coverdell, you must fall beneath the IRS income limit of $95,000 for single filers and $190,000 for joint filers in order to contribute. Those limits won’t affect most of us but the wealthy will be left out in the cold here.
Advantage: 529 – Again, the 529 offers more flexibility with its greater availability.
With 529s, each state provides a menu of choices. Some options are run by the state itself and some are offered through registered investment advisory firms like Fidelity and TIAA-CREF. In each case though, you are limited to the investment choices offered by the state.
Coverdells work similarly to IRAs in that you can choose any investment you’d like for your account – stocks, bonds, mutual funds, CDs, etc. The only caveat is that the investment firm needs to offer the Coverdell account in order for you to invest (Fidelity, for example, does not offer the Coverdell).
Advantage: Coverdell – 529s draw some criticism for their limited options and the Coverdell allows you a much broader range of choices.
State Tax Deduction
Depending on the plan and state of residency, your contributions into a 529 plan account could earn you a state tax deduction.
No such deduction exists for contributions into a Coverdell account.
Advantage: 529 – The state tax deduction is a great bonus with the 529 account as long as you can get it.
So which account type comes out ahead? The cop out answer is that it depends on your circumstances. If you’re looking for an option for saving for college, the 529 is likely your better option. The higher contribution limits, the potential state tax deduction, and its wide availability make it an excellent choice for investors.
However, if you have a youngster attending private school and are looking for some tax savings, try the Coverdell. The contribution limits are a drawback but since 529s don’t allow you to use funds for secondary school expenses, this account may be your best choice.
Both accounts can have a place in your portfolio and both have their advantages. Knowing all of your options will help you keep less of your money in Uncle Sam’s hands and more of it in yours.
Photo credit: DeaPeaJay
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