The topic of 529 plans (more below) came up over the weekend. It had been a while since Michelle and I had talked about them and even longer since I had done any reading. Hopefully this will clear up what kind of options the 529s and the Coverdells offer. For those of you who know nothing about them this should be a good introduction.
To start, naming. A '529 plan' is simply an investment vehicle (like an IRA) named after the pertinent part of the IRS code: section 529. The other option, Coverdell Education Savings Account (Coverdell ESA, Coverdells, ESAs, etc.) work just like an IRA. In fact, its previous name was Coverdell IRA. Both programs work similarly, and can be used in tandem, but offer slight differences in tax implications and funding limits. First we'll describe how these plans are similar then lay out their differences.
Similarities- Both plans are "tax advantaged" vehicles, meaning the money in the program grows tax-free and can be used tax-free (if used properly - no cars, kids). The flip side of this is that these plans are funded with after tax dollars. This is like your Roth IRA and unlike your 401(k) or 403(b)
- Money can be withdrawn for "qualified education expenses". These include not only tuition, but room & board, fees, supplies, even computers
- oThe Owner of a plan can change designated beneficiaries without penalty once per year
- The money in the account is not considered the beneficiary's income as long the owner of the account is someone other than the beneficiary (i.e., parent)
Differences- Coverdell - limited to $2000 per beneficiary per year
- 529 - no contribution restrictions (they are still subject to gifts taxes above $12,000)
- Coverdell - money must be distributed by the time the beneficiary is 30 (or transfered to a qualified relative under the age of 30)
- 529 - no age limits
- Coverdell - almost any kind of investment can be made within a (same as an IRA)
- 529 - only the program-specific investments are allowed
- Coverdell - can be used for (qualified) elementary and secondary education expenses
- 529 - only be used for expenses related to post-secondary education
With all of the above in mind, it looks like the best thing (for us) to do is invest in both. This is for two reasons. First, I have no idea if we will need to pay for a private high school (or elementary school, for that matter). Secondly, I think we could get lower fees, and potentially better investments, with the Coverdell. Though this is beyond the scope of this post, many 529 plans are laden with fees. Though not too high, they do eat away at the investment. The saving grace for 529s are their tax friendliness and lack of caps.
In conjunction with the Coverdells, we will probably invest in a 529 plan as well. This will allow us to go beyond the $2000 a year (if able) that the Coverdells allow us. It will also be a decent tax advantage as long as the program lies within our state of residence.
The other part of all of this, is that if family members want to help out by contributing to a 529 plan instead of, say, giving physical gifts, they can. Family members can even start their own 529 plan if they want to keep it all in one pool and simply disburse the money as needed by rolling over funds to another individuals 529 (only once per year, though - see above).
Before finishing this off, one thing needs to be clear though: Coverdells and 529s alike need to be owned by
a parent not
the beneficiary. If a beneficiary owns their own 529 plan financial aid will count 30% as potential funding. If a parent owns it only 6% will be 'seen'. This is because they assume a parent will only spend 6% of their money on a child's education while an individual will spend 30% on their own education. If another family member chooses to hold an account in their own name and disburse the funds this should be transparent for financial aid purposes, though it does bring up some tax issues that, though not too complicated, would need to be addressed.
That's it! If anyone has any information to add (or correct) feel free to let us know either via comments or otherwise.
