Coverdell and 529 Savings Plans
How to Use Coverdell and 529 Savings Plans to Save for a Child’s Education
If you have a child in your life and you would like to save for their education, the U.S. tax code provides two different tax-advantaged ways. One method is the Coverdell Education Savings Account, and the other is through a Qualified Tuition Plan, more popularly known as a 529 plan. Though the two are both designed to provide tax-free funding for tuition and other allowable expenses, there are significant distinctions that make them very different from each other.
No matter which plan you choose, the best way to maximize the results is to begin making contributions as soon after a child is born as possible. By doing so, your investment earnings have a better chance of increasing and the amount in the funds will have the greatest possible accumulation. Let’s take a look at the differences between the two plans so you can determine which one meets your needs and abilities best.
The Coverdell Savings Account limits the amount of the contribution that you can make each year to just $2,000. That amount can be represented as a single deposit or can be made up of deposits from anybody who wishes to provide the benefit for the child. The only limitation is that a contributor’s adjusted gross income can’t be so high that they phase out of eligibility. This limit is currently established at $190,000 for married contributors filing jointly and $95,000 for everybody else). The tax rules require that the funds in a Coverdell Savings Account be withdrawn by the time that the beneficiary reaches the age of 30 unless they are a special needs student.
The funds are available to be used at any time from kindergarten through post-secondary education, and can be used for a wide range of expenses including the travel required to get to and from the school, room and board, books, and supplies in addition to the tuition itself. Special needs students can use the monies in a Coverdell Savings Account to pay for tutoring expenses. If the funds in one child’s account are needed to help pay expenses for another child in the same family, they can be rolled over from one account to another. Because the longer the funds are in the account, the more the money invested can grow, it makes sense to avoid withdrawing money for as long as possible, but they can begin to be withdrawn as early as kindergarten age.
The Qualified Tuition Plan, or Section 529 Plan, can only be used to pay for expenses for post-secondary education. This mean that the funds are able to accumulate and grow for a longer period of time. Additionally, there are no limits to how much can be deposited each year. Though individual depositors are limited to the gift tax limit, which was $14,000 for 2015, the plan is open to contributions from multiple depositors. Individuals are permitted to make up to five years of contributions in advance under a special rule, meaning that for 2015 they could effectively contribute $70,000 without the funds being considered as exceeding the gift tax rule.
The Section 529 Plan does not have the same type of income thresholds or limitations as the Coverdell Savings Plan, and the only limit on the amount that can be contributed to the plan is determined by the individual state’s projected cost of college education. This number can vary from plan to plan, as some calculate based upon the costs of the country’s most elite and pricey college costs while others base their calculation on the cost of in-state schools. In most cases, 529 Plans are permitted to hold over $200,000, and some have current limits that reach nearly $400,000. Once an individual account reaches its contribution limit, it can continue to grow by earning interest.
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