There are several different types of education savings accounts that can be used to save for your child's future education expenses. The two main education savings account vehicles are Coverdell Education Savings Account and a 529 College Savings Plan. Many individuals also create Uniform Gift to Minors Act (UGMA) custodial accounts and provide funds directly to the child.
Each of these accounts has their pros and cons, and even those vary based on your individual family goals (for example, do you need K-12 tuition money, or only higher-education money).
Here are a few things to consider about each of these methods and education savings accounts.
Coverdell Education Savings Account
Coverdell Education Savings accounts are great because they allow the money to be spent for elementary through college education - a much larger range than other plans.
- Tax Advantage: Use after-tax dollars, but money in the account grows tax free, and no taxes on the distribution if used for education expenses
- Contribution Limit Per Year: $2,000 (you may be able to bypass this limit)
- Income Restriction on Contributor: See latest IRS guidelines
- Very flexible investment choices and can reallocate the portfolio as often as desired (similar to a IRA)
- Distribution Restrictions: Any qualified education expense, including elementary through college (some resources say preschool is eligible, which is a gray area. The IRS specifically doesn't include it, but some states consider preschool to be elementary education due to state laws. Talk to a tax professional before making an assumption on preschool)
- With a Coverdell, once the child reaches 18, the account control is given to the student, and they can do whatever they want with it, including withdrawing it and paying penalties
- Limits of beneficiary age to 30
- K-12 Education: Yes, allowed with no cap
- Student Loans: No, you cannot pay your student loans with a Coverdell account
Read our full guide to Coverdell Education Savings Plans.
529 College Savings Plan
- Tax Advantage: Use after-tax dollars, but money in the account grows tax free, and no taxes on the distribution if used for qualified 529 plan education expenses
- Contribution Limit Per Year: Gift tax exemption level (currently $17,000 per year)
- Maximum Contributions: Varies by state
- Income Restriction on Contributor: None
- Stricter investment choices and can only re-balance the portfolio twice per year
- Distribution Restrictions: Funds are limited to qualifying higher education expenses
- The parent is the permanent account holder, and remains in control of the money for all time
- K-12 Education: Limited to $10,000 per year for tuition only
- Student Loans: Limited to $10,000 per beneficiary
UGMA Custodial Account
A UGMA account isn't specifically used for education savings, but it is an investment account you can use for minors. As such, there are no rules on how to use the money. We love these accounts for getting started investing in high school.
- A UGMA is a custodial account that is used to gift assets to minors
- They can also be UTMA accounts, or Uniform Transfer to Minors Act accounts
- The assets given are owned by the child
- Since the assets are owned by the child, they can impact the child's ability to receive financial aid in the future
- This type of account is beneficial to the giver for tax and estate reasons (avoiding the estate tax and income on the assets are paid at the child's tax rate)
- Tax Advantage: None
- Maximum Contribution: None
- Income Restrictions: None (however, earnings may be subject to the Kiddie Tax)
- Distribution Restrictions: None, the custodian can sell the assets for the child's benefit at any time and for any reason, and the child can once he reaches 18 or 21, depending on the state
Which Education Savings Account Is Best?
So which type of education savings plan is the best? It's a tough choice. Coverdells are great in that they can be used for all education expenses. However, it can be tough to get money into a Coverdell due to the low contributions limits.
529 plans are great, especially for higher education expenses. And the list of ways to use the account continues to grow: K-12 education, student loans, and now even a Roth IRA rollover.
A UGMA is less favored due to potential tax issues, but it allows the money to be used for essentially anything, and is not restricted to educational uses.
Readers, what are your thoughts? Have you ever used any of these types of accounts, or are you considering doing so?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared toward anyone wanting to earn more, get out of debt, and start building wealth for the future.
Editor: Claire Tak