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Tax Planning: Coverdell ESA vs 529

By December 15, 2016No Comments

The two basic tax-advantaged accounts used for college savings are 529 plans and Coverdell Educational Savings Accounts (ESA). Understanding the differences can help make a choice best suited for a given situation.

529 plans are sponsored by individual states under IRS regulations. These plans must be used for the payment of covered higher education costs or will incur full taxation on gains plus a 10 percent penalty upon withdrawal. Higher education includes traditional college and vocational education after high school.

The IRS does not specify an annual limit on contributions but has an effective annual limit due to the treatment of money moved into these accounts as gifts. If a couple wanted to contribute more than $28,000 in a single year, gift taxes would be triggered on any amount greater than the limit. By simply spreading the contributions over multiple years, this tax can be avoided.

Contribution limits for individual plans do exist, but they are high enough that all college cost should be covered.  A typical limit is $300,000, which would be met by a couple contributing up to the gift tax limit in eleven years.

Tuition and books are qualified expenses in the 529 scheme. Computers are not. On campus housing is generally covered, and off campus housing can be at least partially covered. Tax advice should be sought for the details on housing.

Coverdell ESAs are similar to 529 but have some important differences. The greatest advantage is that these accounts can be used for elementary and high school expenses. The first disadvantage is that a limit on modified adjusted income exists ($110,000 for a single, $220,000 for joint filers) for making contributions to the account. The greatest disadvantage is that contributions are limited to $2,000 per year.

The most fundamental aspect of college planning is simply a family commitment to investing for future college expenses. If even a modest savings commitment can be made, the future burden on college students can be significantly lessened. Understanding the tax implications of the specific vehicle, within the family’s complete picture, can be complex. Please contact us if we can help.