How to choose a College Savings Account

Bottom Line:

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:

Coverdell

- 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)

529

- 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.