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Saving for college may help minimize the need to take out student loans to pay for school. Education Savings Accounts (ESAs) and 529 plans both allow you to save on a tax-advantaged basis, but there are some key differences in how they work.
Comparing the features of Education Savings Accounts vs. 529 plans, as well as the pros and cons, can help you decide which one is right for your needs.
Key Points
• Both ESAs and 529 plans offer tax-advantaged ways to save money for qualified education expenses.
• 529 plans allow for higher annual contribution limits compared to the $2,000 yearly cap for ESAs.
• Eligibility to contribute to an ESA is restricted by income levels, while 529 plans have no income-based contribution limits.
• Funds in both accounts can be used for various education-related costs, but ESAs offer broader coverage for K-12 expenses.
• Unused 529 funds offer flexible options such as rolling over the balance to a Roth IRA (with certain limitations) or transferring it to another family member.
Currently, SoFi does not provide ESAs or 529 savings plans.
Education Savings Accounts (ESAs) vs 529 Savings Plans
Coverdell Education Savings Accounts (ESAs) and 529 plans are both designed to help you save money for college, as well as potentially other types of schooling.
These plans can help you avoid a situation where you’re using retirement funds for college. These specialized types of investment accounts share some similarities but also have some significant differences.
Similarities
When putting an ESA vs. 529 plan side by side, you’ll notice that they have some features in common. Here’s how they overlap:
• Contributions to ESA and 529 plans are generally made with after-tax dollars, and potentially grow on a tax-free basis within these accounts.
• Withdrawals are tax-free when funds are used to pay for qualified education expenses, as defined by the IRS.
• You’re not limited to using ESA or 529 plan funds for college; both allow some flexibility in paying for elementary and secondary school expenses.
• Nonqualified withdrawals from ESAs and 529 plans may be subject to taxes and penalties, with some exceptions.
• Both plans allow you to transfer savings to another beneficiary if your student opts not to go to college or there’s money remaining after paying all of their education expenses.
• With both types of accounts, contributions are not deductible on your federal tax return.
Differences
The differences between a 529 plan vs. an ESA largely center on who can contribute, contribution limits, and when funds must be used. Here’s how the two diverge:
• ESA contributions are limited by the IRS to $2,000 per child, per year, while 529 plans don’t have federal annual contribution limits (each state sets an aggregate lifetime limit — typically $235,000 to $600,000+ — on total contributions per beneficiary).
• Income determines your ability to contribute to an ESA but doesn’t affect your eligibility to open a 529 plan.
• ESA contributions are only allowed up to the beneficiary’s 18th birthday unless they’re a special needs beneficiary.
• Remaining funds in an ESA must be withdrawn by the beneficiary’s 30th birthday unless they’re a special needs beneficiary.
• 529 plans have no age limits on who can be beneficiaries, how long you can make contributions, or when funds must be withdrawn.
• Some states allow you to deduct your 529 contributions from your state income tax, but ESA contributions are not tax deductible at the federal or state level.
| Education Savings Account | 529 College Savings Plan | |
|---|---|---|
| Income Limits | You cannot contribute to an ESA if your MAGI is over $110,000 (single filers); $220,000 (married, filing jointly). | Anyone can contribute, regardless of income. |
| Annual Contribution Limit | $2,000 per child | None at the federal level, though contributions above the annual gift tax exclusion limit may trigger the gift tax. Contributions are subject to lifetime limits imposed by each state, but these are typically very high — $235,000 to $600,000+. |
| Eligible Beneficiaries | Students under the age of 18 or special needs students of any age. | Students of all ages, including oneself, one’s spouse, children, grandchildren, or other relatives. |
| Investment Options | May include stocks, bonds, and mutual funds | Typically limited to mutual funds |
| Tax Treatment of Withdrawals | Withdrawals for qualified higher education expenses are tax-free; nonqualified withdrawals may be subject to tax and a penalty on the earnings portion of the withdrawal. | Withdrawals for qualified higher education expenses are tax-free; nonqualified withdrawals may be subject to tax and a penalty on the earnings portion of the withdrawal. |
| Tax Deductions | Contributions are not tax deductible. | Contributions are not deductible on federal returns; some states may allow a deduction. |
| Qualified Expenses | Withdrawals can be used to pay for elementary, secondary, and higher education expenses, including tuition, fees, books, and equipment. | Withdrawals can be used to pay for qualified college expenses; up to $20,000 can be used per year for qualified K-12 expenses. |
| Required Distributions | All funds must be withdrawn by age 30 or rolled over to another beneficiary, unless the beneficiary is a special needs student. | Funds can remain in the account indefinitely or be rolled over to another beneficiary. |
| Financial Aid | Treated as parental assets for FAFSA purpose | Treated as parental assets for FAFSA purposes |
What Is an ESA?
A Coverdell Education Savings Account (ESA) is a tax-advantaged custodial account created specifically to fund a child’s educational expenses. It allows your investments to potentially grow tax-free and offers completely tax-free withdrawals when used for qualified expenses.
Pros and Cons of ESAs
If you’re considering an ESA versus a 529 plan, it’s important to consider the advantages and potential downsides. While ESAs offer tax benefits, there are some limitations to be aware of.
Pros:
• Tax-deferred growth. Funds in an ESA potentially grow tax-free.
• Tax-free distributions. As long as the money you withdraw is used for qualified education expenses, you’ll pay no tax on any growth in an ESA.
• Multiple uses. Money in an ESA can pay for a variety of expenses, including college tuition and fees, books and supplies, and room and board for students enrolled at least half-time. Parents of elementary and secondary school students can use the funds for private school tuition, academic tutoring, and school-mandated costs of attendance, such as uniforms or room and board.
Cons:
• Contribution limits. You can only contribute $2,000 per year to an ESA, and contributions are not tax deductible.
• Income caps. Single filers with a modified adjusted gross income (MAGI) exceeding $110,000 and married couples filing jointly with a MAGI over $220,000 cannot contribute to an ESA.
• Age restrictions. You can’t contribute anything to an ESA once the beneficiary turns 18, and they must withdraw all remaining funds by age 30, unless they are a special needs beneficiary. Withdrawals after the beneficiary turns 30 may be subject to taxes on earnings, plus a penalty, but it’s possible to rollover the funds to an ESA for another beneficiary.
What Is a 529 Savings Plan?
A 529 savings plan is a tax-advantaged account that you can use to save for education expenses. All 50 states offer at least one 529 account and you don’t need to be a resident of a particular state to contribute to its plan.
Pros and Cons of 529 Savings Plans
There may be a lot to like about 529 savings plans but like ESAs, there are also some potential downsides to consider.
Pros:
• High contribution limits. There are no IRS limits on annual contributions to a 529 plan; states can set aggregate contribution limits but these are generally high.
• Broad eligibility. One of the advantages of a 529 savings plan is that anyone can contribute, regardless of income, and there are no age restrictions on who can be a beneficiary.
• Tax benefits. Potential earnings grow tax-deferred and qualified withdrawals are tax-free. In some states, you may be able to deduct your contributions on your state return.
• Flexible funds use. 529 plan funds can be used to pay for qualified college expenses, K-12 private school tuition (up to certain limits), qualified education loan repayment, and eligible apprenticeship expenses.
Cons:
• Tax penalties. Nonqualified withdrawals are subject to a 529 withdrawal penalty and taxes.
• State specificity. You typically only get state tax deductions if you use your own state’s plan.
• Limited investment options. Compared to ESAs, 529 education savings plans may offer fewer investment options
Which Savings Plan Is Right for You?
Deciding when to start saving for college for your child is the first question to tackle; where to do it is the next. Whether you should choose an ESA vs. a 529 plan may hinge on your eligibility for either plan and how much you are able to save.
You might choose an ESA if you…
• Are within the income thresholds allowed by the IRS
• Would like a broader range of investment options to choose from
• Need broader K-12 coverage (ESAs cover a wider array of K-12 expenses, including tutoring, academic uniforms, and special-needs services)
On the other hand, you might prefer a 529 plan if you…
• Want to be able to contribute more than $2,000 a year to the plan
• Don’t want to be limited by age restrictions for contributions or withdrawals
• Qualify for a state tax deduction or credit for making 529 contributions
You might also lean toward a 529 if you want more options for using any leftover funds. Unused funds in a 529 can be rolled over into the beneficiary’s Roth IRA, subject to annual contribution limits and specific IRS rules.
If you’re shopping for an ESA or 529 plan, consider the type of investment options offered and the fees you might pay. You might start with your current brokerage to see what college savings accounts are available, if any.
The Takeaway
Saving for college early and often can give you more time to potentially see your money grow. If you’re torn between a Coverdell Education Savings Account (ESA) vs. a 529 plan, remember that you don’t necessarily have to choose just one. You could use both to save for education expenses if you’re eligible to do so. Just remember to prioritize saving in your own retirement accounts along the way so that you’re not shortchanging your nest egg.
FAQ
Is it better to put money in a 529 or an education savings account?
One of the main advantages of a 529 savings plan is the opportunity to save more than you could with a Coverdell Education Savings Account (ESA), which is limited to $2,000 per year, total, per beneficiary. In addition, some states may offer a tax deduction for contributions to a 529 plan.
What is the downside of 529 accounts?
If you take money out of your plan for anything other than qualified education expenses, you may have to pay tax on the earnings you withdraw, plus a 10% penalty, which could make a nonqualified distribution expensive.
What happens to the 529 if the child doesn’t go to college?
If you opened a 529 savings plan for your child and they decide not to go to college, you do not lose the money. As the account owner, you have several flexible options:
• Roth IRA: Roll over the funds into the beneficiary’s Roth IRA penalty-free (subject to limits and rules).
• Transfer: Transfer the funds into a 529 for another family member, including siblings, parents, or yourself.
• Alternatives: Use the funds for trade schools, registered apprenticeships, or student loan repayment (subject to certain limits).
• Withdraw: Cash out the account, though you will pay income tax and a 10% penalty only on the earnings, not your original contributions.
• Wait: Leave the funds invested; 529 plans never expire.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
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