With the national discussion on student loan debt raging, many parents are doing anything and everything they can to avoid going into hock for a child's college education.
Many are turning to the Coverdell Education Savings Account (ESA) and 529 plans — both of which are excellent college savings vehicles, allowing money to grow tax deferred and proceeds to be withdrawn tax-free.
Of course, there are pros and cons to each type of account that parents should be aware of:
ESA Pros: ESAs are attracting particular attention from families who plan to send their children to private elementary, middle and high schools. Unlike a 529 plan, which limits funds only to college expenses, funds in an ESA can be withdrawn tax-free for K-12 and college expenses. Another pro for some college savers is that the Coverdell allows you to self-direct funds into almost any investment — including stocks, bonds and mutual funds.
ESA Cons: On the downside, ESAs impose annual contribution, income and age limits. The maximum annual contribution is $2,000 per designated beneficiary, but your income must be $220,000 or below when filing jointly ($110,000 for taxpayers filing singly) in order to contribute. Balances in a Coverdell ESA must be disbursed by the time the beneficiary is 30 years old or given to another family member below the age of 30. By contrast, there is no age limit for 529 plans.
529 Plan Pros: If your income is too high or you need to save more than an ESA will allow, a 529 plan may make sense. There are no annual contribution or income limits, and savers who don't want to self-direct their investments can simply opt for the investment choices offered by the 529 plan — including age-based or target-date funds.
529 Plan Cons: While they have been popular with parents, 529 plans can be convoluted — and expensive. You're free to choose another state's plan, if that plan allows nonresident contributions. But plans differ from state to state so you'll need to do your homework. Depending on the state, you may be limited to only a few investment choices and, under federal law, you can reallocate funds only once per year without penalty. Another consideration is that 529 plans do charge an extra layer of fees for the administration of the plan.
A Hybrid Approach
As an alternative to a "one or the other," some parents opt to contribute the maximum amount each year into a Coverdell ESA and then put any extra savings above $2,000 into a 529 plan. Consult with your Financial Advisor to determine the approach that works best for your family.
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