How do Coverdell education savings accounts compare to 529 plans?

Coverdell ESAs are another option you have to help fund your grandchildren's college expenses. Like 529 plans, ESAs represent a tax-deferred and potentially tax-free way to save for college expenses. And unlike 529 plans, ESA withdrawals are tax-free when used for qualifying K-12 expenses in addition to college. However, for grandparents in particular, ESAs pose some issues not faced with 529 plans.

One concern is that only $2,000 per year can be contributed to ESAs for any child and that contributions from all sources are combined for purposes of this limit. If you were to put $2,000 into your grandchild's ESA in the same year that her parents, other grandparents, or anyone else makes contributions to her ESA, the annual limit is exceeded and your grandchild must pay a penalty. It may be difficult or impossible for you to know whether other family members are contributing to ESAs. You probably do not want to take on this risk.

Another concern with ESAs is that grandparents do not retain the same degree of control over contributed funds as 529 plans allow. Most ESA agreements require that the child's parent or guardian be the "responsible individual" on the account, leaving the grandparent out. Even if you were to find an ESA provider (bank, mutual fund, brokerage, etc.) that permits you as grandparent to be the responsible individual, you may not request a refund like you can with a 529 plan. ESA are held as trust or custodial funds for the beneficiary and distributions are reported under the beneficiary's social security number.

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