By now, you probably know how many different savings options there are available for parents and future college students. With so many options, how do you choose the savings account that’s right for you? And do you really understand what the difference is?
One thing is for sure, the college financial aid process has never been easy, and college savings plans are no different. But here’s what you need to know about the difference between 529 Savings Plans and Educations Savings Accounts (ESA).
What is a 529 Savings Plan?
A 529 plan is a savings plan that helps parents save for the child’s education with some tax exemptions. It’s named after Section 529 of the Internal Revenue Code, which created the savings plans in 1996, and offers tax-advantaged investments to cover the cost of education. States and educational institutions operate these plans, and they’re designed to help families put aside money for future college expenses.
What is an Education Savings Account (ESA)?
Education savings accounts (ESAs) are state government-funded savings accounts that help parents finance their child’s education. The money in an education savings account can fund various educational activities at all levels of schooling. Education savings accounts are available in five American states. People who can’t get one of these accounts may take out a Coverdell Education Savings Account instead.
What’s the difference?
There are several differences between these two plans. Here are some fundamental differences you should know before you choose one.
Maximum Contribution Limits
With a 529 Savings Plan, contribution limits vary depending on which state you open your account in. In some states, the limit can be over $500,000 but tend to average about $300,000.
ESA plans have a much lower limit at $2,000 per year until your child reaches 18 years of age.
Your Income & Savings Plans
The 529 plan has no income restrictions. The ESA is only available to couples with a modified adjusted gross income of less than $220,000 ($110,000 for single filers).
What are “qualified expenses”?
For both the 529 and the ESA plans, qualified expenses are anything related to your child’s college education. That includes tuition, supplies, books, room and board, and so much more.
Some plans have restrictions on when and how your child can use the funds. While the 529 has qualified expense restrictions, it doesn’t restrict when you can start saving, when your child can start spending, or when the account needs to be used.
However, the ESA plan restricts you from contributing more money after your child turns 18, and the funds must be used before they turn 30.
Non-qualified Expenses Withdrawal
Both accounts will allow you to make withdrawals for non-qualified expenses. However, they both come with some hefty fees. The withdrawal is subject to federal taxes and a penalty of 10% of the amount withdrawn.
With the 529 plan, each program has its way of investing. While there’s some flexibility at the start, it’s a pretty low-risk strategy throughout.
On the other hand, the ESA plan offers investments within the ESA portfolio and allows you to transfer funds between different investments.
Knowing the difference between investment accounts will help you make choosing a plan easier. If you still don’t know which plan to invest in, you can always reach out to a financial advisor or talk to the financial aid experts here at Frank!