Coverdell educational savings accounts and 529 plans both offer tax-sheltered accounts to save for future education expenses. Coverdells allow you to use distributions for educational expenses of all levels, including primary and high school costs. On the other hand, 529 plans can only be used for post-secondary education costs, such as college or trade school. The contribution limits for Coverdells and 529 plans don't overlap, so you can contribute to both in the same year.
Coverdell Contribution Limits
Each year, only $2,000 can be contributed for each beneficiary, regardless of who is making the contribution. For example, if your child's uncle puts $2,000 in a Coverdell ESA for the child, you can't contribute to an ESA for the child. In addition, you can't contribute to a Coverdell ESA if your income exceeds the annual limits, according to IRS Publication 970. Finally, the beneficiary of the account has to be under 18 years old or a special needs beneficiary.
529 Plan Contributions
You don't have to worry about income limits when making contributions to 529 plans. In addition, the only limit on 529 plan contributions is they cannot "be more than the amount necessary to provide for the qualified education expenses of the beneficiary." For example, if a wealthy aunt contributes $10,000 for your daughter's 529 plan, you can still make any contributions you were planning.
Gift Tax Implications
The gift tax exclusion does apply cumulatively to both 529 plan and Coverdell contributions in the same year. As of 2012, the annual gift tax exclusion is $13,000 per person, per year. For example, if you put $2,000 in a Coverdell and $13,000 in a 529 plan for your son, you're over the annual exclusion. If you're over the annual limit, you won't owe any gift tax until you've used up your lifetime gift tax credit, but you will have to file a gift tax return. As of 2012, the lifetime gift tax credit is $1,730,000. However, any portion of the credit you use during your life will lower the amount of your estate tax credit.
If you want to front-load the 529 plan without incurring gift tax, you can choose to average your contribution over the next five years. For example, if you contribute $50,000 but choose to average it over five years, you are treated as making a $10,000 gift each year. However, the average counts against the annual gift exclusion, so if you contribute $65,000 for an average of $13,000 per year, you won't be able to make any other gifts, such as contributions to the beneficiary's Coverdell. If you only put in $60,000, you average $12,000 per year, leaving you $1,000 each year for other gifts, such as a Coverdell contribution.
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