Both Coverdell ESAs and 529 plans give you an incentive to save for your children's education.
Contributing to an Education IRA--now known as a Coverdell Education Savings Account (ESA)--or a 529 plan is a smart move when saving for a young person's education. The plans function similarly, but there are some key differences.
Function
Both Coverdell ESAs and 529s are tax-advantaged plans that help you save for your children's educations. Qualified distributions, or withdrawals, for both plans are tax-free. Also, both are considered to be the beneficiary's asset when colleges and the federal government calculate financial aid. Neither type imposes a penalty if you change account beneficiaries--i.e., transfer the funds from one child to another.
Types
Coverdell ESA rules are part of the Internal Revenue Service (IRS) code, so they are standard throughout the United States. On the other hand, 529 plan rules vary from state to state. For instance, some states give you a tax write-off for contributing to 529s, while others do not. Each state sets limits on total 529 plan contributions, which range from $100,000 to $350,000. As of 2010, Coverdell ESA contributions cannot exceed $2,000 annually.
Benefits
Coverdell ESAs and 529 plans differ significantly in what each plans considers a "qualified distribution." Coverdell ESAs may be used to pay for K-12 and higher-education expenses, including tuition, room and board, uniforms, books and tutoring. On the other hand, 529 plans are primarily used to save for college tuition.
Misconceptions
Coverdell ESAs and 529 plans are not investments; they are tax-sheltered accounts in which you can place financial assets, like stocks, bonds or CDs. When comparing these two types, you should consider relative advantages of each from a tax perspective, and whether or not you are eligible to contribute.
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