You dream of the day your kids walk across the stage to accept their college diplomas — and you know getting them there will require saving for tuition. Research shows that less than half of the 72 percent of parents who have started saving for college have opened dedicated savings accounts.
When saving for college, there are enormous benefits to opening a tax-advantaged college savings plan. Understanding the benefits of saving for college now can help save you thousands later. Our guide to the 529 versus the Education Savings Account (ESA) will help you decide which to use to finance your kid’s higher education.
ESA vs. 529: The Basics
529 Plan: A 529 is a state-sponsored plan that offers tax-advantaged investments to cover the cost of higher education. Each state offers at least one 529 plan. The costs of plans and their investment selections differ from state-to-state. It’s possible to invest in a plan in another state if you find one that better fits your needs.
ESA: Also called Coverdell education savings accounts, ESAs are a tax-advantaged investment used to fund education. Contrary to a 529, ESA account withdrawals can be used for qualified elementary and secondary school expenses as well as college.
529 Plan: Each 529 plan establishes its own contribution limits, and the maximum contributions can be as high as $300,000 per student. You can make a one-time contribution of $65,000 ($130,000 for a couple) without incurring taxes for the gift under certain rules.
ESA: The maximum contribution for an ESA is always $2,000 per year, from birth to age 18.
Both 529 Plans and ESAs: Contributions are not tax deductible. The contribution is considered a gift. Withdrawals for qualifying educational expenses are not taxed.
Impact on Financial Aid
Both 529 Plans and ESAs: Funds are considered assets of the parent or the account owner.
Both 529 Plans and ESAs: Funds can be used to cover tuition, fees, books, computers and other supplies. They can also be used for room and board for students enrolled at least part-time.
529 Plan: None.
ESA: Contributions must be made before students turn 18. Funds must be used before age 30, but they can also be rolled over to another ESA for a different family member.
529 Plan: None.
ESA: Accounts are only available to couples with modified adjusted gross incomes of less than $220,000 (or $110,000 for single filers).
529 Plan: Each program has its own investment strategies. Some offer the flexibility to choose investment portfolios; others direct funds in a single portfolio.
ESA: You can choose the investments within the ESA portfolio and transfer funds between different investments within the company.
Withdrawal for Non-educational Expenses
Both 529 Plans and ESAs: Funds withdrawn for non-educational uses are subject to federal tax and a penalty of 10 percent.