What’s the Difference Between a Coverdell and a 529?

vitucci-coverdell-vs-529-header-imageYou’ve made the decision to open a college savings account for your child, grandchild, or other loved one. The next question is, what kind of college savings account should I choose?

If you already started looking, you may have encountered both 529 and Coverdell savings accounts.  Both offer tax advantages that can help you put more money towards your child’s education, but they do have important differences. What are they, and how do you choose?

While there are a number of differences between the Coverdell and the 529, the following 5 are the ones that stand out the most:

  1. Contribution limits
  2. Income restrictions
  3. Investment control
  4. Account control
  5. Usage of funds

Let’s take each of them in turn.

Contribution limits

Perhaps the single biggest distinction between a Coverdell and 529 is the amount that you can contribute to the account — and when.

Contribution dollar limit Contribution age limit
Coverdell $2,000 per year towards a single beneficiary (total contributions across multiple accounts can’t exceed $2,000). Unless the beneficiary has special needs, no contributions may be made once he or she turns 18.
529 Many have a soft “lifetime” contribution limit, often in excess of $300,000. Some plans may have additional limits. None. Contributions can be made regardless of beneficiary’s age.

Both accounts take after-tax contributions, meaning that you can’t take a current-year tax deduction on your contribution, but they still have very different rules when it comes to the amount you can save.

Also, contributions to both 529s and Coverdells may be subject to gift taxes.

In other words, for a Coverdell, subtract your contribution of up to $2,000 from the $14,000 annual gift limit. For a 529, be aware that contributions over $14,000 in a year can trigger gift taxes unless you amortize the gift over a number of years (a maximum of $70,000 over 5 years).

Consider speaking to a qualified accountant about your specific financial situation.

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Income restrictions

Your income doesn’t matter when it comes to contributing to a 529 plan: anyone is eligible.

For a Coverdell, be aware that contribution allowances begin to phase out at $95,000 in income for single filers and $190,000 for joint filers.

Investment control

If you want total control over your investments, you might prefer a Coverdell account.

A Coverdell can be opened at any number of banks and mutual fund companies, and they often allow a wide degree of latitude in choosing investments for the portfolio.

By contrast, 529s typically have very limited investment options that are difficult to change over time. While there is a growing trend of offering greater choice, the options in 529s are still very limited when compared to Coverdell accounts.

Account control

As long as the beneficiary is a child, the account owner of either a Coverdell or 529 maintains the ability to:

  • Choose investments
  • Roll the account over
  • Change beneficiaries
  • Manage distributions

This doesn’t change for 529s: as long as the account is open, it’s the owner who maintains ultimate control over the assets in the account. For Coverdells, control may pass to the beneficiary when he or she reaches the age of 18.

Usage of funds

One of the key selling points of the Coverdell is that it can be used for K-12 education expenses as well as college. By contrast, 529s are only eligible for higher education.

For both, distributions used for qualified educational expenses are tax exempt. These include:

  • Tuition and fees
  • Books, computers, and other equipment
  • School supplies
  • Room and board (may be restricted to half-time attendance or more)
  • Special needs expenses

However, there is one other major issue to keep in mind: Coverdell accounts must be distributed by the time the beneficiary is 30 years old.

If there’s any money left in the account at that time, it’ll be distributed to the beneficiary — along with an income tax bill and 10% penalty (unless, of course, there’s a qualified use for the money).

The only exception is for children with special needs. In this case, there is no time limit on distributions.

Most 529s do not have a time limit to utilize funds.

What’s the same?

With both Coverdell and 529 accounts, any qualified educational expenses you make using the account are tax-free — which could boost the amount of money you can put towards a loved one’s education.

Similarly, both accounts are treated the same way when it comes to financial aid. The are considered to be an asset of the account owner, meaning the parent, grandparent, or other family member who opens it.

What does that mean?

Parental assets are discounted on the Free Application for Federal Student Aid (FAFSA), while those owned by other family members aren’t taken into account at all. In other words, how you structure the 529 could help your child could receive more financial assistance for college. Just keep in mind that distributions from a grandparent’s 529 for a child’s expenses could be classified as part of the child’s untaxed income, potentially reducing financial aid in the following year. 1

Because the specifics depend on the state you’re in and the exact ownership of the account, it can be helpful to consult an accountant to make sure you’re strategizing appropriately.

So how do I choose?

While you can have both a 529 and a Coverdell for your child, many people want to have just one. If that’s the case, consider the following questions before making a decision:

  • What do you need these savings for — K-12 or college?
  • How involved of an investor do you want to be?
  • Do you feel comfortable relinquishing control of the account once the beneficiary turns 18?

Before picking any individual 529 or Coverdell option, consider:

  • The tax treatment of the account at the state level
  • The fees associated with the account
  • Whether the investment options align with your risk profile

Choosing between a 529 and a Coverdell account is a balancing act between costs, opportunities, and the personal relationship between you and your loved ones.
If you’re uncertain where to start, it can be helpful to speak to a financial advisor, who can not only help you navigate the investment side of things, but also the tax and interpersonal factors!

Let Us Help!

We can discuss this topic and more in person at a complimentary appointment. As a bay area retirement specialist we can give you a review and make suggestions based on your retirement objectives.

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1 Amy Feldman. “Don’t Let that 529 College Plan Hurt Your Financial Aid.” Reuters Money, April 29, 2013. http://www.reuters.com/article/us-column-feldman-idUSBRE93S0LZ20130429

Important disclosures:

The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by United Planners.

To determine which investments may be appropriate for you, consult with your financial professional. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk.

Neither diversification nor asset allocation can ensure a profit or prevention of loss in times of declining values. United Planners does not render tax advice.

An investor should consider the investment objectives, risks, charges and expenses associated with 529 plans before investing. Most states offer their own 529 programs which may provide advantages and benefits exclusively for their residents and taxpayers. The tax implications of a 529 plan should be discussed with a qualified tax advisor.

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