So, you want to start saving for your child’s education? That’s fantastic! However, if you are planning for your child’s education, the barrage of online information can be quite overwhelming. After learning about the different kinds of savings plans, you’re still left wondering: What is the best type of education savings account for my family? Are there withdrawal penalties? What is the minimum and maximum contribution per year? Which kinds of education expenses do these accounts cover?
The Basics
There are two main types of education savings plans: the 529 college savings plan and the Coverdell Education Savings Account, or ESA. While its original intention was to cover only the cost of postsecondary education, the 529 savings plan was recently amended through the 2017 Tax Cuts and Jobs Act (TCJA) to include education and tutoring expenditures for K–12 education as well.
Other families prefer to finance their child’s education with a Coverdell Education Savings Account, or ESA. This savings plan is an account that allows for families to use funds in a multitude of ways. Like the reformed 529 plan, ESAs can also be used for schooling other than college: private school tuition and fees, online courses, private tutoring, community college, higher education expenses and other approved educational services or materials.
Although there is a growing interest nationwide, right now, only five states have active ESA programs: Arizona, Florida, Mississippi, North Carolina, and Tennessee (Nevada’s program is currently inactive).
Benefits of ESAs
Here are the primary advantages of investing in an ESA:
- Tax-free withdrawals for unlimited qualified expenses for kindergarten through college (the 529 only allows for up to $10,000 for primary or secondary education). Some states even include preschool expenses, too.
- Flexibility in selecting the beneficiary–the funds can be rolled over to a qualified family member of the beneficiary.
- There are many investment options including stocks, mutual funds, exchange-traded funds, and real-estate investment trusts. Accounts can be set up by a bank, brokerage, or mutual fund company.
- You can invest simultaneously in both an ESA and a 529 savings plan in the same year.
- Contributions are not tax deductible, but money will grow tax free until deductions are taken.
As with any savings plans, there are also a few cons to consider:
- Annual contributions are capped at $2,000 for joint filers.
- Must be rolled over to a beneficiary by age 30 (529 savings plan has no age limit). Contributions cannot be made to the beneficiary after the age of 18.
- According to the IRS, there are income restrictions for contributing to the Coverdell Education Savings Account. Particularly, if your MAGI (modified adjusted gross income) is higher, you will not be able to open one of these accounts.
What’s New?
Education Savings Accounts have evolved from the former Education IRAs and as more states take interest in these programs, changes will be instituted on a rolling basis. The primary changes that have taken place in 2019–2020 reflect the available yearly contribution and income for maximum contribution. Originally, Education IRAs only allowed for a maximum of $500. Now, there is a $2,000 yearly maximum contribution. Additionally, the income limit now stands at $190,000 ($220,000 for joint-filed tax returns).
Start an Education Savings Account Today
Now it’s time to set up your ESA! First, you’ll want to choose the exact way you want to invest the money on your child’s behalf. Next, you’ll want to find an institution to set up your account. If you live in a state that does not have an established ESA program, you can find programs with institutions like Cornerstone Fund. Finally, contribute a designated amount each year to the account. It may not seem like much now, but saving up to $2,000 per year can be instrumental in funding your child’s educational milestones.