529 Plans, a Coverdell, and Prepaid Tuition Plans are all tax-advantaged accounts to help you save for education expenses
Sarah asks: How is an Education IRA different from a 529 Plan?
An 'Education IRA' is now referred to as the Coverdell ESA.
Like a 529 college savings account, a Coverdell is a savings account with special tax status to encourage and reward saving for qualified education expenses.
Deposits to both a Coverdell and a 529 account grow tax free until distributed and withdrawals are tax-free when used for qualified educational expenses.
Very different are the requirements for contributing to and withdrawing funds:
- K-12 and college qualified expenses
- $2,000 limit on total annual contributions
- Beneficiary must be younger than 18
- Contributions are not tax deductible.
- Beneficiary must be under 18
- Funds must be withdraw by age 30
- Modified adjusted gross income must be less than $110,000 ($220,000 joint)
- College qualified expenses only
- No annual contribution limit
- No age restriction on beneficiary
- Contributions may be state-tax deductible
- No age limit on beneficiary
- No time or age limit on withdrawals
- No income limit to establish account
If you qualify you may set up both a Coverdell and a 529 for each student beneficiary.
Alert: Withdrawals are only tax-free if used to pay qualified education expenses (QEE). The earnings portion of all non-qualified withdrawals will be subject to income tax plus a 10 percent penalty tax is used for purposes other than a QEE.
Coming soon in this series: 1. How to manage college savings plans for financial aid eligibility; 2. Leveraging 529 accounts a gift and estate tool; 3. Weighing a state tax deduction against 529 plan performance, 4. How to determine if you are eligible for education tax credits.