Financing Education: Coverdell ESA vs. 529 Plans

Personal Finance

May 14

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Saving for a child's future education is a daunting task. After all, the average cost of attending an in-state public college or university currently rings in at $11,610 per year while the average annual cost for a private nonprofit school is approximately $43,350 (per recently published College Board data).

The good news, however, is that options do exist in this respect. Two of the most common? Education savings accounts—also known as “Coverdell accounts”—and 529 college savings plans.

529 college savings plans: an overview

A 529 plan is an investment account that offers tax advantages when saved funds are used for qualified educational expenses. State governments sponsor these funds, each state boasting its own options, rules, and benefits.

The main selling points of a 529 savings plan are that contributions can grow tax-deferred and withdrawals—when used for qualified education expenses (e.g., tuition, books, and other related costs)—are also tax-free at the federal level. Many states also offer additional tax benefits such as state income tax deductions and 529 plan contribution credits.

You can choose from many different types of 529 plans, with most categorized as either a “prepaid tuition” or “college savings” plan.

College savings plans

College education savings plans function similarly to a Roth IRA in that you make after-tax contributions and investments within these accounts (often mutual funds or the like) grow tax-deferred. Funds are flexible as you can generally use them for tuition at any college or university (including eligible international schools), to cover college room and board expenses, for expanded qualified K-12 school tuition coverage (up to $10,000 per year), and/or to pay off qualified student loans (with a $10,000 lifetime limit).

Various options are also available should the account beneficiary no longer need the money due to a scholarship or college plan change, including shifting to a new beneficiary or rolling over a portion of unused funds to a Roth IRA account.

Keep in mind, however, that a college savings plan doesn't come with guarantees; and while you can choose your investments, they may not always perform exactly how you need them to. It’s thus in fact possible to lose money and fall short of your college savings goals.

Prepaid tuition plans

Just as the name suggests, a prepaid tuition plan is a contract allowing you to pay for your child's future college tuition and mandatory fees in advance via a lump sum or regular installments whereby after-tax money is used to purchase "units" or "credits.”

The price of these credits is determined prior to purchase and varies based on the current age of the beneficiary, estimated cost of tuition, and projected rate of return. With prepaid plans, you don't personally choose investment options as plan administrators (state governments) instead pool the money and make these decisions on your behalf.

One appealing feature of prepaid accounts is they protect you from tuition inflation as most states guarantee funds will cover future tuition rates, especially important when you consider a recent Education Data Initiative (research organization) report claims college tuition inflation increased 36.7% from 2010 to 2023.

Unlike many alternative investment options, prepaid tuition plans offer high contribution limits (set by each state) so you can pay enough to purchase all necessary credits. You also won’t lose money if your child decides to attend an out-of-state school; if he/she chooses a school not covered by the plan, you may indeed use what you paid into it already (minus any investment gains made). You can also typically request a refund on your prepaid account should you no longer require the money or name a new beneficiary.

Although most prepaid plans are only available to residents of that same state (and generally feature limited enrollment periods), you can also consider a “private prepaid tuition plan” (also referred to as a “private college 529 plan”) sponsored by hundreds of nationwide private colleges and universities; these doesn’t include state residency requirements.

With respect to how prepaid tuition plans work, the buyer purchases tuition “certificates” to redeem at any participating college. Contributions grow tax-deferred—with tax-free withdrawals when used for qualified education expenses—and plans are guaranteed by participating schools (despite any tuition increases) but don’t offer year-round open enrollment like their private college 529 plan counterparts.

529A savings plans

You may stumble across 529A savings plans—also known as “ABLE” (“Achieving a Better Life Experience”) plans—during your research, these state-run accounts giving individuals with disabilities and their families a tax-advantaged way to cover qualifying disability-related expenses. Click here to read more about financial planning for special needs children.

Coverdell education savings accounts (ESA): an overview

Opened at almost any brokerage firm, bank, or credit union, a Coverdell education savings account is a trust or custodial account set up solely to pay qualified education expenses for designated account beneficiaries.

As with 529 plans, Coverdell accounts are funded with after-tax dollars and money in the account can grow tax-free. This option is more flexible overall, however, as you can apply these funds toward expenses beyond tuition and mandatory fees (e.g., for qualified elementary and secondary education expenses such as books, supplies, Internet access, computer equipment and technology, academic tutoring, and special needs services).

Coverdell ESA limitations

Despite the appeal of Coverdell ESAs, not everyone is eligible to open these types of accounts. For example, those with a modified adjusted gross income (MAGI) exceeding $110,000 (single filers) or $220,000 (married couples filing a joint return) wouldn’t qualify in 2025. Note these income thresholds aren’t imposed on trusts or corporations that make account contributions, effectively enabling you to bypass them altogether.

Furthermore, the maximum annual contribution limit for these accounts is currently only $2,000 per child. The designated beneficiary must be under age 18—unless he or she is a special needs child when the account is established—and contributions are prohibited after he/she turns 18. A failure to adhere to this rule can result in a 6% excise tax.

Financial aid impact on 529 and Coverdell plans

Fortunately, both 529 and Coverdell plans have minimal bearing on financial aid. Furthermore, due to recent FAFSA (Free Application for Student Aid) changes, students are no longer required to report any financial support received from friends or family (including distributions from grandparent-owned 529 college savings plans).

Potential tax implications

Regardless of the savings vehicle, tax-free earnings and withdrawals from either account apply only when funds are used for qualified expenses. Should you put the money towards non-qualified expenses, the earnings portion of the same is subject to ordinary income tax and a 10% penalty on the distribution amount—although exceptions apply to both 529 and Coverdell accounts. Some states also impose additional 529 plan penalties.

Coverdell accounts generally require you distribute funds by the time your child turns 30 (or otherwise roll them over to another child) and withdraw any money left in the account within 30 days of this date; a failure to do so subjects the earnings portion to income tax and a 10% penalty tax.

Additionally, while most people aren’t required to pay a gift tax, know the IRS does impose a tax on large gifts including 529 plan contributions. More specifically, you’d need to file a gift tax return for those totaling more than $19,000 per recipient in 2025—knowing excess contributions above this threshold will count against your lifetime exemption of $13.99 million (as of 2025), requiring you pay taxes after exceeding this amount.

Other Coverdell and 529 account considerations

Anyone (family, friends, etc.) can fund either type of account—provided they meet qualification requirements—and you can even personally open a 529 account and designate yourself as the beneficiary!

Moreover, 30+ states offer a state income tax deduction or credit for 529 plan contributions; in most cases, the taxpayer must contribute to his or her home state’s 529 plan to qualify for a state income tax benefit.

Coverdell vs 529 plans: how to choose?

A 529 plan is typically best for most families, especially considering the cost of college and that no annual contribution limits exist (note aggregate limits do vary by state). However, for some—especially those who don’t want to (or can’t) contribute more than $2,000 annually or want more flexibility in paying for elementary/secondary school expenses—a Coverdell ESA may fit the bill instead.

The bottom line: 529s vs. Coverdell accounts

While a 529 plan is a great higher education savings tool given its lofty contribution limits, a Coverdell ESA is great for those with K-12 expenses beyond tuition costs or those seeking greater diversity in their college savings investments. Don’t know which option is best for you? Consult a financial advisor who can help you assemble a comprehensive plan that’s best for your own unique situation.

Still have questions about saving for higher education expenses? Schedule a FREE discovery call with one of our CFP® professionals to get them answered.

FAQs

Yes, your child can indeed serve as the beneficiary for both and contribute to both accounts in the same year.
Generally speaking, it’s best to withdraw from a Coverdell first as this dictates you withdraw all funds before the beneficiary turns 30 (whereas you can use 529 funds later on to help pay student loans or partially roll them into a Roth IRA).
Yes, provided the 529 plan has the same beneficiary as the Coverdell plan (with only one rollover allowed over a 12-month period). You cannot, however, roll over funds from a 529 plan into a Coverdell account. Most people consider a rollover when the beneficiary approaches his or her 30th birthday, given the corresponding limit.
Beyond offering more flexibility with respect to how you use the funds, Coverdell accounts often feature lower fees and very few restrictions on investment choices (whereas a 529 typically limits you to mutual funds and other investments offered within the plan).
While 529 plan holders can withdraw up to $10,000 in their lifetime to pay down student loans for a beneficiary, they cannot use a Coverdell account to repay student loans.
Yes. You can also avoid taxes and penalties if you deposit the funds within 60 days for the same beneficiary or another qualifying member of the family.