Comparing Education Savings Plans: Coverdell, 529 & ABLE Accounts

9 minute read

Over the past few decades, education costs have skyrocketed. In 1985, average annual tuition costs at a state university were just shy of $4K, while today they exceed $20K. These costs have risen at more than twice the rate of inflation, making it increasingly difficult for families to afford college.

Fortunately, there are a few savings plans that can make paying for college a bit easier.

Option 1: Coverdell Education Savings Account

Coverdell Education Savings Accounts (ESAs) are tax-deferred investment vehicles designed to help families save for education. Many families elect to use Coverdell ESAs to help their children pay for college, but they can also be used for K–12 education.

ESA investments grow tax deferred, and if the funds are used to pay for qualified education expenses, they won’t be taxed when withdrawn.

Here are a few other important things to know about Coverdell ESAs:

  • When the account is established, the beneficiary must be identified and no older than 18. There are some exceptions for older beneficiaries with disabilities.
  • You can change the beneficiary to a different family member if the trust documents allow for it.
  • Funds can be used to pay for higher education, primary school and/or secondary education costs, which often include tuition, books, equipment, supplies, tutoring, uniforms, transportation and internet access.
  • The account owner can contribute to more than one Coverdell ESA, but they can only contribute up to $2K per year to each beneficiary.
  • To receive tax-free withdrawals, all funds must be used by the time the beneficiary is 30.
  • Only individuals with adjusted gross income below certain thresholds can contribute to Coverdell ESAs, but trusts and other organizations can contribute regardless of income.
  • Investments in Coverdell ESAs are self-directed, which gives the account owner the most flexibility of all three education savings plans.

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Option 2: 529 Plans

529 plans, which are sometimes referred to as qualified tuition programs (QTPs), are state-run savings plans for education expenses. The Tax Cuts and Jobs Act (TCJA) broadened the use of 529 plans to cover K–12 school tuition, but many people still use 529 plans to save for college and other postsecondary education.

Like Coverdell ESAs, 529 plans grow tax deferred and will not be taxed when withdrawn if funds are used to pay for qualified education expenses.

Here are a few other important things to know about 529 plans:

  • Account owners can use 529 plans to pay for education expenses directly or to reimburse themselves for paying out of pocket.
  • Withdrawals are limited to $10K per year per student when used to pay for K–12 tuition, but withdrawals are unlimited if used to pay for postsecondary education.
  • 529 plans can be used to pay for up to $10K of the beneficiary’s and their sibling’s student loans each year.
  • You can contribute to both a 529 plan and a Coverdell ESA in the same year for the same beneficiary.
  • You do not have to open a 529 plan in your home state, and most states place little or no restrictions on where the beneficiary resides or goes to school.
  • Investments must be chosen from the predetermined selection offered by the sponsoring state government.

Option 3: ABLE Accounts

ABLE (Achieving a Better Life Experience) accounts are not dedicated education savings plans, but many people use ABLE accounts to pay for education. They are tax-advantaged savings accounts that can help individuals with disabilities pay for qualified disability expenses.

Like Coverdell ESAs and 529 plans, ABLE accounts grow tax free, and growth within the account will never be taxed if withdrawals are used to pay for qualified disability expenses.

Here are a few more key things to know about ABLE accounts:

  • The account beneficiary owns the account.
  • Beneficiaries can only have one ABLE account.
  • Qualified disability expenses are quite broad and may include education, food, housing, transportation, assistive technology and health care costs.
  • ABLE accounts are state-run programs, so compliance, investment options and account fees will vary by state.
  • Most ABLE accounts allow out-of-state beneficiaries to open an account in their state.
  • Investments must be chosen from the predetermined selection offered by the sponsoring state government.
  • In addition to tax savings, ABLE accounts are used to help persons with disabilities build savings without disqualifying them from social programs. For example, Supplemental Security Income (SSI) and Medicaid are only available to individuals whose asset values are below certain thresholds. Even owning a car can disqualify them from these programs. Assets held in ABLE accounts are shielded from these asset tests.

 See below for a helpful comparison of these three education savings plans.

Education Savings Plans Comparison
Coverdell ESAs529 PlansABLE Accounts
Who can be the beneficiary?Anybody 18 or youngerAnybody of any age, even yourselfIndividuals who acquired a disability before age 26
Can the beneficiary be changed?YesYesYes
How much can you contribute per year?$2K per beneficiaryAny amount, but states set lifetime contribution maximums$15K per beneficiary + additional amounts in 2018–2025
Who can contribute?Anyone whose adjusted gross income (AGI) is less than established thresholds ($220K for joint filers and $110K for other filers)AnyoneAnyone
Are contributions deductible for federal tax purposes?NoNoNo
Are contributions considered gifts?YesYesYes
Which expenses qualify?Education costs for college, universities and K–12 schoolsEducation costs for college, universities and trade schools; tuition for K–12 schools (with limitations); and
student loans (with limitations)
Qualified disability expenses, which may include education costs
How are investments managed?Self-directedLimited to the state’s predetermined investment optionsLimited to the state’s predetermined investment options
Who owns the account?The contributorThe contributor, unless a separate account owner is specifiedThe beneficiary

Making the Right Selection

Taxpayers can open one, two or even all three of these savings accounts if they and their beneficiary are eligible. However, because all three savings plans are subject to gift taxes, tax planning is key.

The annual gift tax exclusion in 2021 is $15K per individual. All gifts made to an individual — whether via an education savings program or otherwise — will be considered for the annual exclusion. Anyone who contributes more than $15K to a single individual must (1) file a gift tax return, and (2) reduce their lifetime gift/estate tax exemption, which is currently $11.7M in 2021.

If you want to use a tax planning software that incorporates education savings accounts and gifts taxes, ask for a demo of our Corvee Tax Planning software today.

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