My 4 year old son started Pre-K yesterday. 14 more years, and he’ll be heading off to college, if I have anything to say about it. While I am not 100% convinced that parents should pay for all of their kids college expenses (that’s an entirely different discussion) I have been looking into the different options available for saving for college expenses.
Education Savings Accounts (ESAs)
-An education savings account or Coverdell education savings account, formerly known as an education IRA, is a tax-deferred savings or investment account that can be used for qualified education expenses (tuition, books, uniforms, etc.) at elementary or secondary schools, or college. ESAs allow a person to invest up to $2000 per year per beneficiary (child) in after-tax contributions, which can grow tax-deferred, and withdrawals used for qualified expenses are tax-free.
529 Savings Plans
- A 529 plan, named after the section of the IRS code, is funded with after-tax contributions as well, and also grows tax-free if the money is used for qualified higher education (college) expenses. 529 plans are offered through individual states, but a state’s plan can be used by a resident of that state to attend any accredited college. Also, many states allow non-residents to open accounts. It is a good idea to check your state’s plan first, however, as some states (including Louisiana) provide state tax deductions by residents for contributions and/or matching contributions. Louisiana, for example, matches between 2% and 12% depending on your income, and you are allowed to deduct from your state income up to $2400 per year for individuals or $4800 for married filing jointly. Excess can be carried over as well.
Differences between a 529 and an ESA:
- An ESA can be used for elementary, secondary (high school), or college tuition or qualified expenses. 529 plans can only be used for college.
- ESAs are subject to income limits (phase out starts at $95k for individuals and $190k for married filing jointly). 529’s do not have income limits, or yearly contribution limits, but are subject to a max. lifetime contribution. (although many state limits are $200k +)
- ESAs can be invested in a variety of investments (stocks, bonds, etc.) while 529 plans are limited to what the individual state has to offer, although most offer a variety of mutual funds.
Additional Resources:
529 Plan information- Collegesavings.org
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Thanks for the explanation. So the only reason why I would choose an ESA over a 529 for college savings is if I didn’t like the investments choices for any of the 529 plans?
That is one of the main reasons, especially if there is no state tax deduction
or matching contribution. Another big reason for some is that it can be used for
elementary or high school tuition. Around here where I live, that is a reason
several people I know use one- to save for private school tuition, which can
be fairly expensive at the high school level.
Great article on both the ESA and 529. I started a 529 for my daughter when she was one week old, but waited 2 years for my son. I think it was the first child jitters that I had. I would recommend just starting an account, either way. Get it setup and auto-funded each month. I have my kids 529 with Vanguard as they have low fees, great performance and an easy website to navigate.
I keep telling my buddies to start an account and they just say it’s on the list of things to do. Some hope the grandparents pay for college. Yikes, that’s a lot of pressure on them.
@Scott-
Thanks! You are right, I should just set it up and auto fund it, even if I start off small. Thanks for the advice!
RC,
You have to make sure the 529 is in your name/SS#, otherwise you will hurt financial aid possibilities ( IF financial rules dont’ change in the next 14 years lol).
You may want to check out my post – Introduction to College Planning.
Evan- Thanks for the info. It does make a difference whose name they are in. Will check out your article.