An educational savings account, also called a Coverdell ESA account, and a 529 college savings account are similar ways to set aside money for a student to use for college tuition. Neither offers deductions from income taxes on contributions, but money in either type grows tax-free, and distributions, including earnings, are tax-exempt if used for educational expenses. Contributions to ESAs, however, are limited to $2,000 a year, while there are no limits on 529 contributions. In most cases, you can move money from an ESA to a 529.
Same Account Holder
You can move funds from a Coverdell ESA into a 529 savings account tax-free in most cases. Both accounts must have the same account holder and the same beneficiary. If an ESA is in your name for a specific child, and you set up a 529 in your name for the same child, the transfer is not a taxable distribution of ESA funds. Any withdrawals from the ESA must benefit the named child.
One possible limitation on converting ESA funds to a 529 account is the federal gift tax, which limits gifts from one individual to another to $13,000 a year. However, a Coverdell account owner can shift up to $65,000 by treating the entire amount as five equal gifts. The ESA account owner has to file a gift tax return for each of the five years, but no tax is levied in such a case.
Contribute to Both
An account owner also can contribute to both a Coverdell and a 529 account the same year. Coverdell money is not restricted to use for college but can be used at almost any public, private or religious elementary, secondary or higher-education institution. A 529 plan can be either a savings account or a prepaid tuition plan, which may be restricted to specific schools, but either type is limited to higher education.
A Coverdell ESA is set up with a bank, mutual fund or other financial institution. A 529 plan is state-sponsored, although all 50 states offer at least one type. Not all states, however, offer both savings and prepaid plans, so a Coverdell transfer needs to go into a similar college savings plan. There are no residency requirements for 529 savings, so a parent could transfer Coverdell funds into an appropriate 529 in another state.
- Internal Revenue Service: Qualified Tuition Program (QTP)
- Internal Revenue Service: Coverdell Education Savings Accounts
- Saving for College: Intro to ESAs
- 360 Degrees of Financial Literacy: 529 Plans vs. Coverdell Education Savings Accounts
- Vanguard: College FAQs
- College Access 529: Common Questions About 529 Plans
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