Education Savings Plan

To pay for education-related expenses, an Education Savings Plan offers an advantage(s) over traditional savings accounts. The following list summarizes the various Education Savings Plan options.

529 COLLEGE SAVINGS PLAN

Contributions:
- INCOME LIMIT: None
- DEDUCTIONS: Similar to a Roth IRA in that contributions are not deductible (i.e. after-tax) at the federal level. Some states allow a deduction for contributions (see more)
- LIMIT: To avoid gift tax, for a married couple, $28,000 per year per Beneficiary. A couple can leverage Form 709 to contribute five years worth ($140,000) in a single year (see more).
Distributions:
- QUALIFIED DISTRIBUTIONS – only for college (i.e. accredited, postsecondary institution eligible to participate in a student aid program)
  - Federal Taxes: Tax-free!
  - State Taxes: Generally exempt (see more)
- NON-QUALIFIED DISTRIBUTIONS
  - Federal Taxes: Earnings taxed as ordinary income & 10% penalty on earnings
  - State Taxes: Generally, earnings taxed as ordinary income & contributions taxed if they were originally deducted
Financial Aid Impact: Considered asset of the Owner, not the Beneficiary
Beneficiary: Owner can also be the Beneficiary; Beneficiary can be changed to another member of the family
Control:
- REVOCABILITY: Contributions considered revocable gifts
- ACCOUNT CONTROL: Owner controls the account; child is Beneficiary

UTMA/UGMA – CUSTODIAL ACCOUNT

Contributions:
- INCOME LIMIT: None
- DEDUCTIONS: None
- LIMIT: To avoid gift tax, for a married couple, $28,000 per year per Beneficiary
Distributions: Can be used for non-college expenses but still must be used for the benefit of the Beneficiary who must be a minor. At least part of the investment earnings may be exempt from federal income tax, and some or all may be taxed at the child’s rate.
Financial Aid Impact: Considered asset of the Beneficiary, not the Owner
Beneficiary: Cannot be changed
Control:
- REVOCABILITY: Contributions considered irrevocable gifts
- ACCOUNT CONTROL: Custodian controls the account until it is transferred to the Beneficiary at the age of majority (i.e. 18 or 21 depending on state)

COVERDELL EDUCATION SAVINGS ACCOUNT (ESA)

Contributions:
- INCOME LIMIT: As of 2015, can only contribute if modified adjusted gross income (MAGI) is less than $220,000 (filing jointly)
- DEDUCTIONS: Similar to a Roth IRA in that contributions are not deductible (i.e. after-tax) at the federal or state level.
- LIMIT: $2,000 per year per Beneficiary
Distributions:
- QUALIFIED DISTRIBUTIONS – for primary, secondary, as well as postsecondary education
  - Federal Taxes: Tax-free!
  - State Taxes: Generally, tax-free!
- NON-QUALIFIED DISTRIBUTIONS
  - Federal Taxes: Earnings taxed as ordinary income & 10% penalty on earnings
  - State Taxes: Depends on the state
Financial Aid Impact: Considered asset of the Owner, not the Beneficiary
Beneficiary: Must be under 18; Beneficiary can be changed to another family member
Control:
- REVOCABILITY: Contributions considered irrevocable gifts
- ACCOUNT CONTROL: Owner controls the account; child is Beneficiary.

ROTH IRA

Contributions:
- INCOME LIMIT: Depends on modified adjusted gross income (MAGI). For 2015, the limits are:
  - MAGI < $183,000: Can contribute up to the limit
  - $183,000 <= MAGI < $193,000: Can contribute a reduce amount
  - MAGI >= $193,000: Zero
- DEDUCTIONS: Contributions are not deductible (i.e. after-tax).
- LIMIT: For 2015, $5,500 ($6,500 if you’re age 50 or older) (reference)
Distributions:
- DISTRIBUTION OF CONTRIBUTIONS: Contributions are considered to be withdrawn first and are tax-free because you already paid taxes on them
- DISTRIBUTION OF EARNINGS:
  - Qualified Expenses – for qualified higher education expenses – Tax-free!
  - Non-Qualified Expenses – Earnings taxed as ordinary income & 10% penalty on earnings
Financial Aid Impact: Not considered assets on the Federal Application for Student Aid (FAFSA)
Beneficiary: Owner is the Beneficiary as long as he is still alive
Control: Owner controls the account

My Take

Depending on individual situations, 529 Plans, Coverdell ESAs, and Roth IRAs have better tax advantages than UTMA/UGMAs. In addition, a Beneficiary, as young as 18 years old, can gain full control of an UTMA/UGMA. Depending on the young adult, that can be a scary proposition.

When considering 529 Plans vs. Coverdell ESAs, 529 Plans appear to be the winner. Unlike 529s, Coverdells are not revocable. In addition, a Coverdell Beneficiary can only accumulate $2,000 per year.

That leaves 529 Plans vs. Roth IRAs, and the winner is Roth IRAs. What happens if your kid doesn’t go to college? With a 529 Plan, you can change the Beneficiary to another family member, but other than that, you are stuck paying the penalty. With a Roth IRA, you have the option of keeping the money for your retirement. In addition, what if you contribute too much to a 529 Plan? With student loans irrationally surpassing comprehension and tuition continually outpacing inflation, something’s gotta give. So, setting a target savings amount is difficult. With a 529 Plan, you will pay a penalty on funds that you don’t use for postsecondary education.