There are several types of education savings accounts that you can use to save for your child’s future education expenses. The two main Education Savings Account vehicles are the Coverdell Education Savings Account and the 529 College Savings Plan. Many individuals open Uniform Gifts to Minors Act (UGMA) custody accounts to fund their children directly.
Each of these accounts has its pros and cons, and it also depends on individual family goals (for example, do you need K-12 tuition or just higher education money?).
There are a few things to consider about each of these methods and education savings accounts.
Coverdell Education Savings Account
A Coverdell Education Savings account is great because it allows you to spend money on your education from grade school through college, so it’s much more versatile than other plans.
- Tax advantages: You use after-tax dollars, but the money in your account grows tax-free and is not taxed on your distributions when used for educational expenses
- Annual Contribution Limit: $2,000 (may bypass this limit)
- Contributor income limit: look Latest IRS Guidelines
- A very flexible investment choice, allowing you to reallocate your portfolio as needed (similar to an IRA)
- Distribution restrictions: Eligible educational expenses, including grade school through college (some resources cover preschool, but this is a gray area; the IRS doesn’t specifically include it, but state law requires preschool some states consider it primary education, consult your tax expert before making preschool assumptions)
- With Coverdell, once a child reaches 18 years of age, control of the account is given to the student, allowing them to withdraw their account, pay penalties, and do whatever they want.
- Recipient age limit Up to 30 years old
- K-12 education: yes, no cap allowed
- student loans: No, you can’t pay student loans with your Coverdell account
Read our complete guide to Coverdell Education Savings Plans.
529 College Savings Plan
529 College savings plans are great because they save you more money, but you’re limited in what you can do with that money without getting penalized.
- Tax advantages: We use after-tax dollars, but the money in your account grows tax-free and your distributions are not taxed when used for educational expenses on eligible 529 plans
- Annual Contribution Limit: Gift tax exemption level (currently $17,000 per year)
- Biggest contribution: varies by state
- Contributor income limit: none
- Investment choices become more stringent, and portfolio rebalancing can only be done twice a year.
- Distribution restrictions: Funding is limited to eligible higher education expenses
- Parents are permanent account holders and are in constant control of their money
- K-12 education: Limited to $10,000 per year for tuition alone
- student loans: Limited to $10,000 per beneficiary
Find your state with the 529 Plan Guide here.
UGMA custody account
UGMA accounts are not specifically used for educational savings, but are investment accounts that can be used for minors. There are no rules on how to spend money. I love these accounts to start investing in high school.
- A UGMA is a custody account used to gift assets to minors.
- they can also UTMA accountor uniform remittance to a minor law account
- The property given is owned by the child
- Assets are owned by the child and may affect the child’s ability to receive financial assistance in the future
- This type of account is beneficial to the giver for tax and estate reasons (avoids estate tax, property income is paid at child tax rate)
- Tax advantages: none
- Biggest contribution: none
- Income limit: None (but earnings may be subject to child tax)
- Distribution restrictions: none. The custodian may sell the property for the child’s benefit at any time and for any reason. Also, a child can be sold when she reaches the age of 18 or 21, depending on the state.
Which education savings account is best?
So which type of education savings plan is best for you? It’s a tough choice. Coverdell is great in that it can be used for all educational expenses. However, due to the low donation limits, it can be difficult to put money into Coverdell.
The 529 plan is great, especially for higher education expenses. Also, the list of account usage methods continues to grow. K-12 education, student loans, and now a Roth IRA rollover.
UGMA is less favored due to potential tax issues, but the money can be used for essentially anything and is not limited to educational uses.
What do you think, readers? Have you used these types of accounts or are you considering using one?