Coverdell and 529 Education Savings Plans
Category: Education Planning
Tags: Tax Planning
- Coverdell Education Savings Accounts
- Qualified State Tuition Programs (Sec 529 plans)
- Savings Contribution Limits
- Gift Tax Issues
The tax code provides two primary advantageous ways of saving for your children’s education. We frequently get questions about the differences between the programs and about which program is best-suited for a family’s particular needs.
The Coverdell Education Savings Account and the Qualified Tuition Plan (frequently referred to as a Sec 529 Plan) are similar; neither provides tax-deductible contributions, but both plans’ earnings are tax-free if used for allowable expenses, such as tuition. Therefore, with either plan, the greatest benefit is derived by making contributions to the plan as soon as possible—even the day after a child is born—so as to accumulate years of investment earnings and maximize the benefits. However, that is where the similarities end, and each plan has a different set of rules.
Coverdell Savings Accounts only allow a total annual maximum contribution of $2,000. The contributions can be made by anyone, including the beneficiary, so long as the contributor’s adjusted gross income is not high enough to phase out the allowable contribution. (The phase-out threshold is $190,000 for married contributors filing jointly and $95,000 for others.) Unless the beneficiary of the account is a special needs student, the funds must be withdrawn prior to age 30. The funds can be used for kindergarten through post-secondary education. Allowable expenses generally include tuition; room, board, and travel expenses required to attend school; books; and other supplies. Tutoring for special needs students is also allowed. Funds can be rolled over from one beneficiary to another in the same family. Although the funds can be used starting in kindergarten, the chances are that not enough of earnings will have been accumulated by that time to provide any significant benefit.
On the other hand, state-run Sec 529 plan benefits are limited to postsecondary education, but they allow significantly larger amounts to be contributed; multiple people can each contribute up to the gift tax limit each year. This limit is $14,000 for 2015, and it is periodically adjusted for inflation. A special rule allows contributors to make up to five years of contribution in advance (for a total of $70,000 in 2015).
Sec. 529 Plans allow taxpayers to put away larger amounts of money, limited only by the contributor’s gift tax concerns and the contribution limits of the intended plan. There are no limits on the number of contributors, and there are no income or age limitations. The maximum amount that can be contributed per beneficiary is based on the projected cost of college education and will vary between the states’ plans. Some states base their maximum on an in-state four-year education, but others use the cost of the most expensive schools in the U.S., including graduate studies. Most have limits in excess of $200,000, with some topping $370,000. Generally, once an account reaches that level, additional contributions cannot be made, but that doesn’t prevent the account from continuing to grow.
Which plan (or combination of plans) is best for your family depends on a number of issues, including education goals, the number and ages of your children, the finances of your family and of any grandparents or other relatives willing to help, and a number of other issues. For assistance in establishing education savings plans, please give our office a call.