What are the differences between the Coverdell ESA and a 529 plan? I'm trying to figure out what's going to be the best choice for my family.
Linda, the most notable difference between a Coverdell ESA and a 529 plan is the contribution limit.
Coverdells have a cap of $2,000 per beneficiary per year from all sources (which has been discussed in Congress to be reduced back down to $500, but so far stays at $2,000) of contributions and they have an income phaseout for incomes between $190,000 and $220,000 (joint filers) or $95,000 and $110,000 (single). This means your ability to contribute decreases within that range and phases out completely (meaning you cannot contribute) after you hit the high number in the range. 529 Plans set their own limits, but many have a maximum of over $300,000 per beneficiary without any income restrictions. Coverdells often offer lower account fees and broader investment options; however, with the lower contribution level, if your intended savings amount is higher than the limit, then you will have to find an alternative means to save. There is nothing wrong with multiple solutions (as I mention later), but I wanted to be sure to call that out if managing multiple accounts is not appealing.
Another difference is the time restriction of the Coverdell versus the 529. Coverdell funds must be used before a beneficiary reaches age 30, and contributions halt at age 18. Of course, you can transfer the account to a different beneficiary within the family if you do not expect the funds to be used by the first beneficiary. 529 Plans do not carry these restrictions unless the specific plan states a limit.
Keep in mind that you do not have to take advantage of any of the college savings vehicles to pay for college -- or use them exclusively. Many people choose to invest in a regular brokerage account, paying capital gains on the sale of assets when it is time to pay for college. This route opens up the potential use of the funds (rather than limiting it to education and the rules of the education accounts) and gives ultimate flexibility in investment choices. What I find for my clients is often a mix of education savings vehicles (either Coverdell or 529Plans depending on the contribution amount they expect to make) and regular investment accounts are the right solution.
One final note: Make sure you are saving for your retirement to the degree that you need to to reach your savings goal. Often times, I see parents putting aside for their children's education without contributing or minimally contributing to their retirement accounts. While you may feel you'd rather give to your child, too often I see children who end up feeling the financial strain later when they have to support their parents in retirement right when they are embarking on their own future.