Well, it’s that time again. School is back in session and parents are reminded that college tuition bills are looming. When families start thinking about saving for a child or grandchild’s education, two options often come up: the Coverdell Education Savings Account (ESA) and the 529 Plan. At first glance they appear similar, both offer tax advantages if used for education, but there are important differences that can make one more suitable than the other.
I would describe an ESA as the “starter” account for education savings. Parents or grandparents can put aside up to $2,000 per child each year, and those funds can be used for a wide variety of expenses, from private school tuition to tutoring to college costs down the road. ESAs also offer broad investment flexibility, since the money can typically be invested in individual stocks, bonds, or mutual funds. The catch, however, is that contributions are not only limited to these $2,000 caps, but also by the contributor’s income. Families with higher earnings may not qualify to put money in these accounts at all.
By contrast, 529 Plans like Missouri’s MOST 529 are built for bigger goals. The contribution limits are far higher, allowing families to save hundreds of thousands of dollars over time for one beneficiary. And unlike ESAs, there are no income restrictions, so anyone can contribute, from parents to grandparents to family friends. Missouri even offers a state tax deduction for contributions, which can make saving more appealing. While the money in a 529 is most often used for college and post-secondary education, recent law changes now allow up to $10,000 per year to be used for K–12 tuition as well. Investment options are much more limited than in an ESA which might reduce potential growth.
Another attractive feature of 529 Plans is a relatively new rule from the SECURE Act 2.0, which allows unused funds in a 529 to be rolled into a Roth IRA for the beneficiary under certain conditions. This means that if a child doesn’t end up going to college, or simply doesn’t need all the money saved, the account can still provide a huge benefit to the individual’s future success by giving them a jumpstart on their retirement savings. While there are limits on how much can be rolled over each year and a lifetime cap, this provision gives parents and grandparents additional peace of mind that their contributions won’t go to waste.
The bottom line is that education is one of the most important investments a family can make. Whether you choose an ESA, a 529, or a mix of both, the key is to start saving early and consistently. That way, when the time comes, you’ll be ready to give your child or grandchild the opportunities they deserve.
(Past performance is no guarantee of future results. The advice is general in nature and not intended for specific situations)