By The Galecki Financial Management Team
A 529 plan offers the highest contribution room, tax-free growth for education costs, and a state tax credit for Indiana residents. A Coverdell ESA allows a much smaller annual contribution with more flexibility in how K-12 money is spent. A UTMA account can be used for anything, and the child takes full control at 21.
Education savings accounts are one of the better ways to start putting money aside for a child or grandchild. With the changes Congress has made over the past few years, they deserve a closer look in your overall financial plan than they used to get.
The 529 plan is the one most families have heard of, and it now does more than pay for college. The Coverdell Education Savings Account (ESA), sometimes still called an education IRA, and accounts under the Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) each carry implications well beyond tuition, including tax, estate, and retirement planning questions you may not have considered.
Here’s how the three compare, and how we help families in Fort Wayne decide between them.
529 Plan vs. Coverdell ESA vs. UTMA at a Glance
| 529 Plan | Coverdell ESA | UGMA / UTMA | |
|---|---|---|---|
| Annual contribution limit | No federal dollar limit, though gifts above the annual exclusion count against your lifetime gift exemption | $2,000 per beneficiary from all sources combined | No limit, though gifts above the annual exclusion count against your lifetime gift exemption |
| Income limits to contribute | None | Yes, contributions phase out at higher incomes | None |
| How earnings are taxed | Tax-deferred growth, tax-free for qualified education expenses | Tax-deferred growth, tax-free for qualified education expenses | Taxable each year, partly at the child’s rate and partly at yours |
| What the money can pay for | College, K-12 tuition and certain K-12 costs, apprenticeships, and up to $10,000 lifetime in student loans | College and a broad range of K-12 expenses (including tutoring, books, and technology) | Anything that benefits the child |
| Who controls the money | You, as the account owner, for the life of the account | You, as responsible individual, until the beneficiary turns 30 | You, as custodian, until the child reaches 21 in Indiana |
| Indiana tax benefit | 20% state tax credit on contributions to CollegeChoice 529, up to $1,500 ($750 if married filing separately) | None | None |
| Leftover money | Change the beneficiary, or roll up to $35,000 lifetime into the beneficiary’s Roth IRA after 15 years | Must be used or distributed by age 30 | Belongs to the child outright at 21 |
The 529 Plan
The 529 helps families pay for college, and it’s been expanded over the years to cover K-12 education and registered apprenticeship programs as well.
You can also use the money to pay up to $10,000 in student loans, and since Jan. 1, 2024, up to $35,000 of leftover money can be rolled into the beneficiary’s Roth IRA, as long as the 529 has been open at least 15 years.
There are two basic types of 529 plans: education savings plans and prepaid tuition plans. Money in a 529 plan grows tax-deferred, and withdrawals are tax-free when spent on qualified education expenses such as tuition, books, and supplies. An education savings plan can be used at nearly any school. A prepaid tuition plan lets you lock in today’s tuition cost for future attendance.
Funds in a 529 stay under your control as the owner, yet they’re excluded from your taxable estate. That makes a 529 one of the few places where you can move money out of your estate and still decide when and how it gets spent.
529 plans differ by state. In Indiana, you can take a state income tax credit of 20% of your contribution, up to $1,500 ($750 for those filing separately), through the CollegeChoice 529.
The Coverdell Education Savings Account
The Coverdell ESA, often overlooked and sometimes still called an education IRA, is a trust that helps families below certain income levels pay education expenses for a beneficiary. The beneficiary generally must be under 18, unless the person qualifies as having special needs.
Coverdell contributions are capped at $2,000 per year per beneficiary, counting everything contributed from all sources including family members, organizations, and trusts. Where the Coverdell shines is K-12 flexibility: it can cover tutoring, books, supplies, and technology, while 529 money spent on elementary through high school is limited to tuition.
Distributions are tax-free when used for qualified expenses. Anything withdrawn beyond those expenses has a portion taxed at the beneficiary’s rate. If the beneficiary turns 30 before the money is spent, the remaining balance is distributed to them within 30 days.
An Account Under UGMA and UTMA
A UGMA or UTMA account lets you set money aside for a child without setting up a trust. You can transfer nearly anything of value into it, including cash, stocks, bonds, mutual funds, and real estate. You hold the account as custodian until the child reaches the age of majority, which is 21 in Indiana.
Contributions are made with after-tax dollars. Gifts up to the annual exclusion amount can be made without touching your lifetime gift tax exemption. Any income the account generates is taxable in the year it’s earned: the IRS allows the first portion tax-free, taxes the next portion at the child’s rate, and taxes anything above that at your rate. These thresholds are adjusted periodically.
You don’t own the account, though you can spend money from it for the child’s benefit. Once the child reaches the age of majority, you’re removed as custodian and the account becomes theirs to use however they choose, education or otherwise.
Can You Use a Roth IRA for College Savings?
Some families ask about this, and it’s worth understanding. Contributions to a Roth IRA can be withdrawn at any time without tax or penalty, which makes a Roth a possible backup source of education money. Earnings are a different story, and withdrawing them early can trigger taxes.
The tradeoff is that every dollar you pull out for tuition is a dollar no longer growing for your own retirement. We usually walk through this one carefully, because parents can borrow for college and nobody lends for retirement.
How to Choose Between Them
Most of the families we work with land somewhere in these three patterns:
- You’re saving mainly for college and you live in Indiana. The 529 is usually the starting point, because of the state tax credit, the higher contribution room, and the Roth rollover option for leftover money.
- You’re paying significant K-12 costs. A Coverdell ESA alongside a 529 can cover expenses the 529 won’t, such as tutoring and technology. You’re allowed to fund both for the same child in the same year.
- You want flexibility beyond education. A UTMA account covers anything that benefits the child, with the understanding that the money becomes theirs at 21, with no strings attached.
Grandparents have a few extra considerations around gifting and financial aid, and the right answer there often depends on timing. That’s a conversation we have often.
Choose the Right Education Savings Accounts for Your Family
Deciding which education savings accounts to use has implications well beyond funding school. The Galecki Financial Management team helps individuals and families in Fort Wayne, throughout Northeast Indiana, and around the country pursue an ideal financial future for their family.
We provide our personalized financial planning services on a Fee-Only basis, which means you can trust that we’re always, and only, looking out for your interests as we help you choose. To schedule a meeting, call (260) 436-8525 or email [email protected].
Frequently Asked Questions
What is the difference between a 529 plan and a Coverdell ESA?
A 529 plan has no federal annual contribution cap, no income limits, and a state tax credit for Indiana residents. A Coverdell ESA caps contributions at $2,000 per year per child and phases out at higher incomes, and it covers a wider range of K-12 expenses.
Which is better, a 529 plan or a Coverdell ESA?
For most families saving primarily for college, the 529 does more, mainly because of the higher contribution room and the Indiana tax credit. A Coverdell can be a strong complement when you’re paying for private school, tutoring, or technology before college.
What is an education IRA?
Education IRA is the old name for the Coverdell Education Savings Account. The account was renamed years ago, and many people still search for it by the original name. They’re the same account.
Can you have both a 529 plan and a Coverdell ESA for the same child?
Yes. You can fund both for the same beneficiary in the same year. Families often use the 529 for college costs and the Coverdell for K-12 expenses a 529 doesn’t cover.
What is the difference between a 529 plan and a UTMA account?
A 529 grows tax-free for education and stays under your control. A UTMA account is taxable each year, can be spent on anything that benefits the child, and becomes the child’s property outright at 21 in Indiana.
How is a Trump Account different from a 529 plan?
A 529 plan is built for education, and withdrawals are tax-free when spent on qualified school costs. A Trump Account is a general savings account for a child that isn’t limited to education, with its own contribution rules and timing. Families often use both, for different purposes.
For the details on how these accounts work, read Trump Accounts: What Families Need to Know.
What happens to leftover money in a 529 plan?
You have options. You can change the beneficiary to another family member, hold the account for a future grandchild, or roll up to $35,000 lifetime into the beneficiary’s Roth IRA once the 529 has been open 15 years.
Does Indiana offer a tax break for 529 contributions?
Yes. Indiana residents can claim a state income tax credit of 20% of contributions to a CollegeChoice 529 plan, up to $1,500 per year ($750 if married filing separately).
Related Reading From Our Team
Planning for College Expenses With Help From Fee-Only Advisors
What Is a Fee-Only Financial Advisor & Why Does It Matter?
Trump Accounts: What Families Need to Know
About Galecki Financial Management
At Galecki Financial Management, we help individuals and families confidently pursue their financial goals. We’re anything but a business-as-usual wealth management firm. We’re different. Friendly. Casual. And really good listeners. Indeed, that’s a big part of what makes us different. Everything we do is based on what we hear from you, because our experienced team of professionals specializes in comprehensive financial planning, cash flow analysis, IRA rollovers, financial services, money management, estate planning, retirement planning, and advising. We help you identify your short- and long-term goals, and then we work together to pursue them. Lastly, and most importantly, we’re Fee-Only, meaning we’re only compensated for our time. Our only incentive is to help you succeed.