The Lexington Group: Education Savings Accounts—529s and Coverdells

Tokyo New York Asia Financial Services - With college costs on the rise, financing a child's higher education can be a challenge. There are two types of education savings accounts that are specifically designed to help parents, grandparents and others save for a child's educational expenses on a tax-advantaged basis.

Both 529 plans and Coverdell Education Savings Accounts (CESAs) permit after-tax contributions that grow tax-free until distributed. With both, distributions used towards the qualified education expenses of the beneficiary at an eligible educational institution are free from federal and in most cases, state income taxes. Unlike other vehicles used for education savings such as UGMA/UTMA accounts, with both 529s and CESAs, you control the account including who is beneficiary and changing the beneficiary, how much to contribute, and when and how much to distribute. You can also choose to make contributions to both a 529 and a CESA on behalf of the same beneficiary during the same tax year.

An important factor to understand about 529 plans is that they are sponsored by individual states. The states determine the maximum contributions, eligible investments and state tax advantages for their programs. Therefore, state plans vary greatly in their tax benefits, investment options, costs and features. By contrast, CESAs work more like IRAs in that you can choose any investment options available through the financial institution you choose to serve as your CESA custodian or trustee. Residents are not required to invest in their own state's 529 plan, and distributions do not need to be used to pay for schools only within the contributor's or beneficiary's state of residence. In addition, individuals may contribute to more than one state's 529 plan.The chart below compares the important features of these two types of education savings accounts:

Making significant gifts to a 529

529s have a special feature known as accelerated gifting. Instead of just gifting $13,000 per beneficiary per year using the annual exclusion, you may contribute five years of gifts in the first year for a total of $65,000 per individual (or $130,000 for married couples filing jointly) without paying gift tax. This also removes this money from your estate. Taking advantage of this option allows you to make significant contributions early and benefit from the tax-deferred growth within the 529 account.

Let’s talk about it

The best way to prepare for education expenses is to become familiar with your savings options and determine how each can address your specific needs. Give us a call today to discuss 529s, CESAs and other education savings alternatives in light of your current goals, objectives and financial situation.