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3 Different Education Savings Plans Compared

During tax season, you hear about all sorts of tools to help you save on taxes and help you plan your investments more prudently. If you have children, you might want to consider saving for their education.

There are several options for education savings. The three that most people consider are the custodial account, the Coverdell ESA, and the 529 Plan.

Let's look at all three.

Custodial Accounts

These accounts are like basic trusts for minors. An adult opens an account for the benefit of a minor. The custodial accounts are an irrevocable gift to the minor. You can contribute up to the gift tax annual exclusion amount every year (that's $14,000 per recipient by an individual or $28,000 by a married couple).

  • Tax Benefits: The first $950 of unearned income is tax-free. The next $950 is taxed at the child's federal tax rate.
  • Pros: The amount in the account isn't just limited to education expenses. The funds in the account can be used for any reason to benefit the minor.
  • Cons: It's not tax-deferred. The investment earnings in the account are taxed. Also, this account is in the child's name and as such, can effect the child's eligibility for financial aid.

Coverdell ESA

These plans let you contribute up to $2,000 per beneficiary annually until that child turns 18.

  • Tax Benefits: The earnings are tax-deferred. Also, qualified withdrawals are tax-free.
  • Pros: The earnings are tax-deferred. Another good thing about Coverdell plans is that they can be used to pay for elementary and secondary education.
  • Cons: You can only contribute a certain amount per year. Also, these plans are limited to those within a certain income bracket. Married couples with a gross income of over $220,000, and single filers with a gross income of $110,000, are excluded from contributing to this plan.

The 529 Plan

These plans allow tax deferred growth of investment earnings.

  • Tax benefits: You don't pay tax on investment earnings until you withdraw the money (they're tax deferred). If the money is withdrawn for education, it's tax-free.
  • Pros: You can gift up to $70,000 per individual or $140,000 per married couple annually without incurring gift tax.
  • Cons: These plans apply to post-secondary education expenses.

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