It's worth noting that contributors are now allowed to contribute to both a Coverdell ESA and Section 529 plan in the same year (although contributions to both types of plans are combined for gift tax purposes). This is great for parents who want to save more than the $2,000 per year allowed in a Coverdell, or for parents who want to save for college in a 529 plan while also saving for elementary and secondary school costs in a Coverdell ESA.
• Section 529 plans. These plans are quickly becoming the savings vehicle of choice for many parents and grandparents. A 529 plan offers the same potential tax-free savings for college as a Coverdell ESA. Most 529 plans are run by individual states, the majority of which make their plans available to any U.S. resident (rather than just residents of their state). This means a great variety of plans are available to today's college saver. Students are not required to attend college in the state where their 529 plan money is invested either; they can use the assets at any accredited post-secondary institution in the U.S.
Unlike Coverdell accounts, there are no annual income limitations for 529 plan contributors, making 529s the natural choice for high-income college savers. In addition, while Coverdell ESAs limit contributions to $2,000 per beneficiary per year (combined from all contributors), with a 529 plan an individual can contribute up to $11,000 per year to a single beneficiary (that limit being the maximum annual gift tax exclusion). There's even a way to boost this already high limit: a contribution of up to $55,000 can be made up front, and treated as five consecutive annual contributions for gift tax purposes. Given that these limits are per contributor, a couple could effectively give double these amounts to a single beneficiary. For most people, this means 529 plans offer them the ability to save as much as they can without worrying about any restrictions.
Don't be dissuaded if you don't happen to have $11,000 laying around to fund a 529 plan with. Even small amounts invested regularly over an extended period of time can grow surprisingly large. For example, if you can save $75 per month for 18 years and the plan averages returns of 10% per year, you'll end up with $45,418. That may not cover all of Junior's college expenses, but it'll sure put a big dent in them.
Most 529 plans are managed by mutual fund companies and offer a range of investment options. Usually, one or more age-based portfolios are available that automatically adjust the percentage of stocks, bonds, and cash in the account according to a preset formula as the child ages. In addition, many states are adding "static" investment choices which allow the contributor to select a certain mutual fund or mix of mutual funds that will remain constant unless the contributor initiates a change. Each state offers a different set of investment choices, making this both a difficult and important area to compare between state plans.
A final advantage of 529 plans is that the contributor retains control and ownership of the account. This is important on several levels. For starters, it means that the contributor can pull money out of the account at any time and for any purpose, although taxes and a 10% penalty will result from unqualified distributions. It also allows for a great deal of flexibility in changing the beneficiary from one child (or grandchild) to another. Having the 529 plan considered as a parental asset is likely to help in financial aid calculations, as student-owned assets count more heavily in the calculations than do parent-owned assets. And perhaps most importantly, it ensures that a child who decides not to go to college doesn't wind up with an unintended financial windfall. A 529 plan may not only be a valuable vehicle to help you provide for the costs of a college education, but also to protect your children from receiving a large sum of money that they aren't spiritually and socially equipped to handle yet.
