Coverdell Education Savings Account
A Coverdell Education Savings Account (ESA) is a trust account that assists families in funding educational expenses. While ESAs offer greater control, they are much more restrictive when it comes to contributions, income level restrictions, and age restrictions. Beneficiaries must be under the age of 18 when the account is established and the total maximum contribution per year is $2,000 per beneficiary. Unspent funds in the account must be distributed when the beneficiary reaches age 30, subject to tax and a 10% penalty if distributions are not for qualified education expenses. Federal tax law allows the beneficiary to be changed to another family member without triggering any tax or penalty, granted the new beneficiary is under age 30. Contributions to an ESA must be made in cash and are not tax deductible. Additionally, contributors must contribute by the due date of their tax return.
For more information, visit the IRS page here.
529 Plans
A 529 plan is an investment account that allows contributions to grow tax-deferred and withdrawn tax-free when used for qualified education-related expenses, including tuition for K-12 and college, room and board (limited to cost posted by the applicable university), apprenticeship programs, student loan repayments (up to lifetime limit of $10,000), books and supplies, and Roth IRA contributions (starting in 2024). Nontaxable proceeds from a 529 plan cannot be claimed as qualified higher education expenses for calculating education-related tax credits (like the federal American Opportunity Credit or Lifetime Learning credit) or deductions (like the Wisconsin tuition subtraction).
Although contributions are not deductible for purposes of federal income tax, some states offer deductions if contributions are made to the state-sponsored 529 plan. For information regarding the Wisconsin subtraction, click here.
A strategy often called ‘superfunding’ allows an individual to contribute as much as 5x the annual gift tax exclusion amount in a single year by reporting the 5-year gift tax averaging election on Form 709.
For more information on Wisconsin’s 529 Plan (Edvest), click here.
Taxability of Coverdell and 529 Plans
If assets in a Coverdell or 529 plan are distributed for non-qualified expenses, federal income tax and a 10% penalty are applied to the earnings. State income tax and penalties may be due on both the contribution and earnings if the contribution was previously deducted on the state income tax return.
For a video explaining the taxability calculation, click here.
Coverdell ESA vs 529 Plan
| Coverdell ESA | 529 Plan | |
| Contribution limits | Annual contribution limit of $2,000 | Up to the gift tax exemption amount annually and most have lifetime contribution limits of $350,000 or more |
| Income level restrictions | You can only contribute to a Coverdell ESA if your annual income is less than $110,000 (single) or $220,000 (couple) | No income level restrictions |
| Age of beneficiary | You can only open accounts for beneficiaries who are under 18 and can only make contributions until they reach age 18. All funds need to be withdrawn by the time the beneficiary reaches age 30. | No restrictions on age of the beneficiary |
| Investment options | Self-directed investments possible, including any specific investments that you prefer. | You can only choose from the investments offered under the plan |
| Elementary and secondary tuition and expenses | Both covered | Tuition only, up to $10,000 per year. |
| College tuition and expenses | Both covered | Both covered |
| Tax benefits | Contributions grow tax-free, no federal or state deduction for contributions | Contributions grow tax-free, no federal deduction for contributions, state may offer deduction |