Everything You Need To Know About College Savings Accounts
Is it almost time for your son or daughter to go off to college and finally stop mooching off of your hard earned money make you proud? Planning financially for college can be tricky, especially when it comes to taxes.
There are two types of accounts you can open to save for those not so cheap college expenses further down the road. These two types of accounts are Coverdell Education Savings Accounts and 529 Plan accounts.
Let’s start with the Coverdell Education Savings Account.
A Coverdell account is typically set up for the higher education expenses of a child. The funds you contribute grow in the account tax deferred and the money comes out for education expenses tax free.
There is no tax deduction for the amounts you contribute to a Coverdell. But you do have significant investment options including self-directed investment options (similar to IRA rules). A Coverdell has the following rules and benefits:
- There are zero federal or state income tax deductions on Coverdell accounts.
- Parents (or grandparents) can contribute without limitations to a Coverdell until a beneficiary reaches age 18 if the contributor has income of $190k (married joint) or $95,000 (single). For all the “ballers” out there, keep in mind that your child can always contribute to their own account with gifted funds (no need to have earned income).
- Funds can be used for tuition, fees, books, and equipment for college as well as certain K-12 expenses.
- $2,000 annual contribution limit per beneficiary (e.g. child or grandchild).
- Accounts can be invested into stocks, mutual funds, and can even be self-directed. Similar to an IRA.
- Contributions grow tax-free and can be withdrawn for education expenses until the account beneficiary reaches age 30. Unused amounts can be transferred to another family member beneficiary.
And now for the 529 Plan account.
Your contributions to a 529 Plan account can be eligible for a state income tax deduction (depending on your state). Money contributed to your 529 Plan account is invested into a state managed fund. A 529 has the following rules and benefits:
- Money can be withdrawn for tuition, fees, books, supplies, equipment, special needs, room and board.
- There are no federal tax deductions or credits for contributions.
- Up to $300,000 can be invested per beneficiary by any person.
- Money is invested into a state run program.
- Many states (hopefully yours) offer tax deductions for contributions to 529 Plan accounts. Thirty-five states offer some type of state income tax deduction for 529 Plan contributions. However, there are some states, like California, who offer no tax deduction for contributions to 529 Plan accounts.
- Your money must be invested solely into state run programs. There are no other investment options.
As you can see, the main difference between the two accounts is that Coverdell accounts have the benefit of allowing you to decide how your contributions will be invested, but the money is not tax deductible.
On the other hand, contributions to a 529 Plan account must go to a state run fund, but that money is usually eligible for tax deductions.
Below is a chart that outlines everything that was said above. Happy college planning!