Ask a Fool: What's Wrong With Using a Coverdell ESA to Save for College?

Q: I know there are two college-specific savings accounts -- the 529 savings plan and Coverdell ESA. However, the 529 is the only one I see discussed in the news most of the time. Is there something wrong with using a Coverdell to save for college?

There's nothing wrong with using a Coverdell ESA to save for college expenses. However, the reason you likely see the 529 savings plan discussed more often is that it has some big advantages over the Coverdell.

For one thing, you're only allowed to save $2,000 per year in a Coverdell ESA, while 529 savings plans only have aggregate maximums -- usually in the hundreds of thousands. So, even if you max out a Coverdell every year, it might not compound enough to cover the cost of college.

Another big advantage is that 529 savings plan contributions are state tax-deductible in many cases. In fact, this is the primary reason I chose a 529 over a Coverdell to save for my kids' college expenses.

Furthermore, the Tax Cuts and Jobs Act took away one of the biggest advantages of a Coverdell. It used to be true that 529 savings plan funds were only usable for college expenses, while Coverdell ESAs could be used for educational expenses at any level. Now, 529s can be used to pay for secondary and elementary educational costs as well.

The one remaining advantage of Coverdell ESAs over 529s is investment flexibility. While a 529 savings plan is designed more like a 401(k), a Coverdell ESA allows the account owner to invest in virtually any stock, bond, or mutual fund. However, this benefit is generally outweighed by the dramatically higher contribution limit and the state tax advantages of 529 savings plans.