This summer, parents are increasingly looking forward to the day their kids will be out of the house, but dreading the cost of their new residence: college. As you consider college saving plan options, consider the two most common tax favored savings tools available: the Coverdell Education Savings Accounts and 529 Plan accounts. The Coverdell account contributed funds grow in the account tax deferred and the money comes out for education expenses tax free. There is no tax deduction for amounts contributed to a Coverdell but you do have significant investment options. A Coverdell has the following rules and benefits.
- Parents (or grandparents) can contribute to a Coverdell until a beneficiary reaches age 18.
- $2,000 annual contribution limit per beneficiary (e.g. child or grandchild) phases out when the contributor has income of more than $190k (married joint) or $110,000 (single). TAX TIP: For high-income earners, keep in mind that the child can always contribute to their own account with gifted funds (no need to have earned income) so you can always get around the income limitation by having the child contribute themselves.
- Funds can be used for tuition, fees, books, and equipment for college as well as certain K-12 expenses too.
- Unfortunately, there are zero federal or state income tax deductions on Coverdell accounts.
- Accounts can be invested into stocks, mutual funds, and can even be self-directed. They operate similar to an IRA.
- Contributions grow tax-free and can be withdrawn for education expenses until the account beneficiary reaches age 30. Unused amounts can be transferred to another family member beneficiary.
The second type of account is a 529 Plan account, which is eligible for a state income tax deduction in Oregon and most states. Money contributed to a 529 Plan account is invested into a state managed fund. A 529 has the following rules and benefits.
- Amounts are invested into a state run program.
- Amounts can be withdrawn for tuition, fees, books, supplies, equipment, special needs, room and board.
- Up to a few hundred thousand dollars can be invested per beneficiary by any person.
- There are no federal tax deductions or credits for contributions.
- Thirty-five states offer some type of state income tax deduction for 529 Plan contributions. For example, Oregon offers up to a $4,750 tax deduction for married tax filers. However, there are some states, like California, who offer no tax deduction for contributions to 529 Plan accounts.
- Downside, invested amounts must be invested solely into state run programs. There are no other investment options.
In summary, Coverdell accounts have the benefit of allowing account owner’s to decide how the money will be invested with zero tax deductions available on contributions while 529 Plan accounts give you zero investment options (all funds go to state run fund) but offer state income tax deductions in most states, including Oregon.