If college savings accounts were the The Brady Bunch girls, the Coverdell Education Savings Account would be Jan, and she'd be whining, "529, 529, 529!" instead of "Marcia, Marcia, Marcia!"
She'd have a point. State-sponsored 529 savings plans get all the attention. While much of it's warranted, the Coverdell ESA doesn't look too shabby either. It allows for the same tax-free growth on investments earmarked for higher-education expenses, and then some. So let's square the two off (the 529 and Coverdell, not Marcia and Jan) for a College Savings Smackdown.
In this corner, the 529 savings plan
- Contribution limits are huge -- well over $100,000 per beneficiary in most cases. This dwarfs the $2,000 annual contribution limit for Coverdell beneficiaries.
- Many states offer perks to residents who participate in the local plan. The most common benefit is the deductibility of contributions on state income tax returns.
- The assets in a 529 plan are considered the property of the donor, usually a parent or other relative. This has two benefits: 1) The student won't gain control of the money and spend it on a new car, and 2) the money will have a gentler effect on financial aid eligibility since colleges expect students to contribute a larger portion of their assets to the tuition bill than is expected of parents.
The challenger: Coverdell
- The Coverdell is a tax-free account until the government changes its mind. However, the tax-free status of 529 plans will automatically revert to tax-deferred (i.e., no taxes will be paid until money is withdrawn) in 2011 unless Congress acts.
- The money in a Coverdell can also be used for qualified elementary and secondary education expenses, including computers and uniforms.
- The Coverdell offers much more investment flexibility. Just open an account with a discount broker and choose just about any stock, bond, or mutual fund you want. Participants in a 529 savings plan are limited to the mutual fund-type investments offered by the sponsor. Since the latter are so new, many don't have long-term performance histories.
- Along with flexibility comes the ability to hold down costs. Generally, you'll pay more in fees and expenses to participate in a 529 plan than you would to invest in low-cost index funds through a discount broker.
So which is better? You guessed it: It depends on your circumstances. But here's the good news: You can have both (again, not Marcia and Jan). You can split your contributions between a 529 and a Coverdell, and enjoy the benefits of both. Also, you can transfer assets from a Coverdell to a 529 plan, but not the other way around.
These are just the highlights. For more on your options, visit our College Savings Center or check out our latest book, The Motley Fool's Guide to Paying for School: How to Cover Education Costs From K to Ph.D.
And since we're sure you're wondering, we'll tell you: Cindy Brady would be a UGMA -- the little one with the cute name who no one understands.
