College Funding Vehicles – A Refresher

College Funding Vehicles

Springtime is when our thoughts turn to warmer weather, allergies, and funding for college. Did we save enough? Did we use tax-advantaged accounts? This is a good time for a refresher on the basics of the main college funding vehicles from contributions to withdrawals.

The accounts primarily used for education savings are 529 Plans and Coverdell Education Savings Accounts (ESA).


529 plans are tax-advantaged savings accounts for the education expenses of a named beneficiary. There are two types of plans: savings plans and pre-paid tuition plans.

The 529 savings plan feels similar to a 401K during the contribution phase with a limited menu of investment options offered by a specific investment company. The funds may be used for any level of education; K-12, graduate, and post-graduate. A pre-paid 529 tuition plan pools the contributions of all investors in the plan and allows them to pay to prepay the cost of college tuition at today’s prices for use in the future with no individual investment options.

Coverdell ESAs are also tax-advantaged savings vehicles for education of a named beneficiary. Depending on the trustee of the ESA, investment choices are much more flexible.


There is an annual contribution limit of $2,000 in the ESA and there are income limits (similar to Roth IRAs) for contributors. Although varied by State, most 529 plans have lifetime contribution limits greater than $250,000 and there are no income limits on contributors. Also, 529 plans may be “front-loaded” with 5 years of gift-tax exclusion ($15,000/yr) contributions at once. For a married couple, that puts up to $150,000/beneficiary to work quickly! Talk to a tax advisor when using this option.


An ESA may not be opened for any beneficiary aged 18 or older (possible exception for a beneficiary with special needs). 529 savings plans may be opened and receive contributions at any age while pre-paid plans may impose age restrictions in some states (consult with plan administrators on specific plans).

The ESA has another unique age-restriction—the account must be closed once the beneficiary reaches age 30 (unless the beneficiary has special needs).

Withdrawals and Tax Treatment

At the federal level, there is no tax deduction for contributions made to either type of account (although individual states may offer one). Qualified withdrawals (withdrawals used to pay the qualified education expenses of the beneficiary) are free from taxation at the federal level (may vary at the state level). There may be some tax benefit for participating in an in-state 529 plan—depending on the state. There is no in-state benefit in NC.

In both types of plans, withdrawals that are not used for the beneficiary’s qualified education expenses (non-qualified withdrawals) are taxed similarly to early withdrawals from Roth IRAs—the earnings portion adds to income and incurs a 10% federal penalty. For 529 plans, the person receiving the distribution (typically the account owner) pays the tax. In the ESA, the beneficiary generally pays the tax. State taxes and penalties may also apply.


Control may be an issue for participants. In 529 plans, the owner of the account controls investment decisions, disbursements, and naming of beneficiaries. The level of control in an ESA may vary by trustee. In 529 plans and ESAs, the beneficiary may be changed to any qualified family member of the previous beneficiary without penalty. After age 18 in an ESA, control may be passed to the beneficiary until age 30 when the account must be distributed.

Financial Aid and Scholarships

Each plan is considered an asset of the parent if the parent is the account owner (which is more favorable than if the account was classified as an asset of the student). Withdrawals for qualified education expenses are not counted as income for the parent or student.

Withdrawals may be taken from 529 plans free of penalty equal to the amount of a scholarship—though taxes are still owed on earnings. Financial aid treatment of 529 plans and Coverdell ESAs is complex and subject to change. Consult a financial planner experienced in financial aid issues for more information.

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