529 Plans vs. Educational IRAs

by Rebecca Lake ; Updated April 19, 2017

If you're a parent, the prospect of paying for your child's college education may seem daunting. According to the College Board, the average cost of attendance as of the time of publication is $16,140 for students enrolled in a four-year public college or university and $36,993 for students enrolled at private institutions. Investing in a state-sponsored 529 plan or education IRA can help to offset higher education expenses while potentially offering certain tax advantages.

Who Can Contribute

The Internal Revenue Services (IRS) imposes different guidelines concerning who may contribute to an education IRA or 529 plan. As of the the time of publication, you can contribute to an education IRA, also known as a Coverdell Education Savings Account (ESA), if your modified adjusted gross income is $110,000 or less for single filers or $220,000 or less for joint filers. There is no income limit for contributions to a 529 plan and you may contribute to any state's plan, regardless of your actual state of residence.

Contribution Limits

Lifetime contribution limits for 529 plans vary. Depending on your state's plan, you may be able to contribute upwards of $300,000 or more. Under IRS rules, single filers may contribute up to $13,000 in a single tax year to a 529 plan without incurring any gift tax. The limit increases to $26,000 for joint filers. As of the time of publication, the IRS limits annual contributions to a Coverdell ESA to $2,000 regardless of filing status. You can no longer contribute to an education IRA once your beneficiary turns 18. There is no age restriction for 529 plan contributions.

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Qualified Education Expenses

Funds held in a 529 plan may be used to pay for qualified education expenses at an eligible educational institution. An eligible educational institution is any college, university or school that can participate in federal student aid programs. According to IRS guidelines, qualified expenses include tuition, books, fees and room and board for students who are enrolled at least half-time. Computers are also covered if they are a requirement for enrollment. Contributions to a Coverdell ESA may be used to pay for higher education expenses or education costs associated with an elementary or secondary school. Qualified expenses include tuition, room and board, books, fees, uniforms, transportation, tutoring, computers, equipment and supplies.

Tax Considerations

Contributions to a Coverdell ESA are not deductible on your federal or state taxes. Depending on your state of residence, you may be able to claim a deduction for contributions to a 529 plan. Distributions from both an education IRA and a 529 plan are tax-free as long as the funds are used to pay for qualified education expenses. If you withdraw funds for purposes other than education expenses, you must pay regular income tax on earnings as well as a 10 percent tax penalty. You must use all funds held in a Coverdell ESA prior to the beneficiary's 30th birthday in order to avoid a tax penalty. There is no distribution requirement for 529 plans.

References

About the Author

Rebecca Lake is a freelance writer and virtual assistant living in the southeast. She has been writing professionally since 2009 for various websites. Lake received her master's degree in criminal justice from Charleston Southern University.

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