529 Plan vs. Coverdell Account Pros & Cons After Tax Reform

How 2017’s TCJA Affects Your 529 Plan vs. Coverdell Account Decision

Most people have heard of education savings plans – the popular 529 Plan and the lesser-known Coverdell Education Savings Account. In 2017, the TCJA expanded 529 Plans to cover education costs from K through 12, in addition to trade schools, college, and graduate school. This matched a provision that was always part of the Coverdell ESA.

This change is a very big deal.

It means that millions of people can now pay education expenses tax-free with income generated by a 529 Plan. It also means there are now fewer differences than ever between a 529 Plan and a Coverdell ESA.

So let’s look at the similarities between the two vehicles. A 529 Plan and a Coverdell ESA are both investment accounts that act like a Roth IRA, allowing money to grow tax-free until it’s withdrawn. And when it’s withdrawn to pay qualified education expenses, it’s still tax-free. Neither permit you to deduct contributions on your federal return, but depending on where you live and the 529 Plan you have, you may be able to claim a deduction on your state return.

But there are also important differences. While anyone can contribute to a 529 Plan, many states impose a $300,000 max value cap, at which point there can be no more contributions unless the allowed amount increases. Plus, annual contributions over $14,000 may be subject to federal gift taxes. While there is no limit on the amount of money in a Coverdell ESA, contributions are limited to $2,000 a year and contributors’ annual income must be below $110,000 ($220,000 filing jointly). The other major difference is in your investment choices. A Coverdell ESA allows you to invest in a variety of stocks, bonds, and mutual funds, while a 529 Plan restricts you to a few state-approved funds.

Regardless of which type of account you have, however, if the money isn’t used, the account custodian can always roll over the funds to a new, younger beneficiary tax-free.