There are two types of tax-advantaged college savings plans designed to help parents finance education:529 Plans and Education Savings Accounts (also known as ESAs or Coverdell accounts).
Both types of accounts offer tax-deferred growth. As long as the proceeds are used to finance qualified education expenses (like tuition, books, supplies, computers, and room and board), the money—including any gains and investment income—can be withdrawn tax-free. And both plans are considered to be your assets, not your child’s, which means their impact on financial aid is significantly reduced.
But there are some important differences in terms of eligibility and the amounts you can contribute.
A 529 plan is a state-sponsored, tax-advantaged way to invest significant assets toward the cost of education. Each state offers at least one 529 plan, and each plan has a program manager. Plans vary by state and differ on costs, program features and investment selection. You do not have to live in a state to participate in that state’s 529 plan. (However, you should check to see if your home state offers a plan that provides its taxpayers with state tax and other benefits only available if you invest in the home state plan.)
Important facts about 529 plans:
Anyone can open a 529 account.
Friends and family can contribute to the account regardless of who opened it.
There are no income limits for opening and funding a 529 account.
Withdrawals from a 529 account can be used to pay for qualified educational expenses at any eligible U.S. postsecondary institution. Beginning in 2018, withdrawals can also be used for K-12 education expenses.
A 529 plan account has higher contribution limits than other types of education savings accounts and gives the account owner control and flexibility not offered by most other types of college savings accounts.
Lifetime contributions can total $300,000 or more (the amounts vary by state) per beneficiary.
If you have the resources, you can jump-start your children’s college funds by depositing up to $75,000 in a single year (a couple can invest up to $150,000) without incurring a gift tax, as long as you make a special election and the contribution is your only gift to that beneficiary for five years (the IRS views the gift as $15,000, or $30,000 for a couple, over five years).
Education Savings Accounts
ESAs, also known as Coverdell accounts, are another tax-advantaged education savings option. Withdrawals can be used for qualified elementary and secondary education expenses as well as for postsecondary school. There are, however, qualifications and restrictions to consider before opening an ESA.
Important facts about ESAs:
Only couples with adjusted gross incomes of less than $220,000 are eligible to open ESAs (for individuals, that figure is $110,000). The income limit for making a maximum contribution is $190,000 (or $95,000 for individuals).
Contributions are limited to a maximum of $2,000 per year until the beneficiary’s 18th birthday.
The account must be liquidated at age 30; however, the designated beneficiary may roll over the full balance to a different Coverdell ESA for another family member, thus avoiding the taxes and penalty.
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