How to Know Which College Savings Accounts Are Right for Your Family (& the Unique Way Investors Can Maximize Savings!)

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Are you looking forward to when it’s finally time to push your sweet little darling child out of the nest and into the real world? This can be a bittersweet moment for parents on several levels. Being financially prepared to pay for college takes careful planning. But never fear—we’re here to help.

This article will cover the two most common types of accounts used for covering college expenses. These are the Coverdell Education Savings Account and the 529 Plan. Each comes with its own benefits, limitations, and tax procedures. Get the details below to determine which will be best for your family.

The Coverdell Education Savings Account

A Coverdell account is a common way to save for your child’s higher education. It allows invested money to grow tax-deferred, and when it is later spent for education expenses, such as tuition, you are able to do so tax-free.

There is currently no tax deduction for contributions to a Coverdell account. You can, however, take advantage of other investment options. The rules are similar to those in place for IRAs.

Related: Parents: Stop Contributing to 529 Plans for College. Use This Superior Method Instead.

The Basic Rules for Coverdell Accounts

Here are the four most critical things to understand about Coverdell College Savings Accounts:

1. There are zero federal or state income tax deductions on Coverdell accounts.
2. As of 2018, individuals can contribute to a Coverdell until the child reaches age 18 if contributors’ modified adjusted gross income is less than $220,000 (if married and filing a joint tax return) or $110,000 (if single). Keep in mind that your child can always contribute to their own account with gifted funds (no need to have earned income). Consider yourself fortunate if you have such a financially savvy kid.
3. Funds can be used for tuition, fees, books, and equipment for college, as well as certain K-12 expenses.
4. There are $2,000 annual contribution limits (in total from all contributors) per beneficiary (e.g., child or grandchild). 

There are also some additional benefits to the Coverdell account. For instance, you have a lot of freedom to self-direct your investments. Some types of investments you can take advantage of include stocks, bonds, and mutual funds. Also, your contributions will grow tax-free. While contributions may only be made up until the student is 18, the account’s beneficiary can draw from the funds until age 30.

In theory, this means even some graduate expenses could be covered, which is a significant advantage if your student knows they intend to pursue graduate education for their desired career. If your child doesn’t use all of the money, that’s OK. It can easily be transferred into another account.

Now let’s look at your other option.

The 529 Plan

The 529 plan does come with a clear tax advantage: Funds you contribute can be eligible for a tax deduction. The value of this deduction will depend on your state. 529 plans are, in fact, managed by the state. But before you elect to use a 529 plan, be aware of its rules.

The Basic Rules of 529 Plans

Here are the three most critical pieces of information you need to know when considering a 529 plan:

1. Money can be withdrawn for tuition, fees, books, supplies, equipment, special needs, and room and board.
2. There are no federal tax deductions or credits for contributions.
3. Plan contribution limits vary from state to state, from as low as $235,000 to up to $500,000 (as of 2019), so be sure to find out the specifics for your plan prior to choosing this type of account.

Though distinct from a Coverdell account, the 529 plan has benefits of its own. The most obvious of these is the potential state tax deduction (however, there is no federal tax benefit). Fortunately, this is currently available in over 30 states. Do a little bit of research to see if your state is on the list. 

You also have fewer investment options when you use a 529 plan. In fact, all money must be invested into state-run programs. There are no alternatives at this time.

Related: College Tuition “Hacks”: 9 Alternative Ways to Pay for Schooling

Other Ways Investors Can Pay for College

Which account is best for you will depend on your ability to make contributions, as well as the goals of your future student. Some families may prefer the Coverdell if the student knows they want to enter a line of work that will require graduate education, such as law or medicine. Similarly, families who expect large expenses during the K-12 period, such as private school costs, may find this account easier to use.

The 529 plan, while only applicable to higher education, may be more appealing for those who wish to save for a longer period of time or contribute an overall higher amount to the student’s education. Meanwhile, Coverdell accounts enjoy tax-deferred growth and tax-free distributions for elementary, middle, and high school education costs.

If you’re still undecided, you may want to know that you can use both plans. It’s not always practical, but it’s one or two more options for saving for college expenses.

Contribute to Both a Coverdell Account and a 529 Plan

You can indeed choose to use both types of accounts, and most universities will accept payments from both. This isn’t a realistic option for every family, as your personal situation may disqualify you from using one type of account. That said, if you’re able to take advantage of both, there’s no reason not to.

Use a Land Trust to Pay For College Expenses

Real estate investors have a less-known way to use income from their real estate investments toward a student’s college education. In fact, I paid for my own college education using the method I will outline below. The critical tool you will need is a land trust, also known as a title-holding trust. The good news is that nearly any type of real estate investment may be held in a land trust.

Here are the steps I personally used to cover my own college education. I’ve kept these fairly simple in the interest of space but am happy to answer any additional questions you may have on this subject.

How to Pay for College With a Land Trust

1. Invest in a property and secure it in a land trust. You will want to name the student as the beneficiary of the trust. As a bonus, the property will be more protected from lawsuits by being deeded to the Anonymous Trust.
2.  Sell an option or interest in the land trust. You will need one for each student. So if you have two children to save for, you can use two land trusts or divide the interest in a single property between them.
3. Get the property appraised. You need to know its current value for Step 4.
4. Let appreciation work its magic. Time alone will do this, but you can of course force appreciation, or an increase in your property’s value, by making improvements to the property.
5. Cash out when tuition is due. There are two easy ways to do this. The student will have the right to sell their interest already. But if you want to keep the property, you can simply buy it back from the student and put those funds toward education.

Pretty cool, right? Savvy investors who take this approach can escape the limits of conventional college savings and allow their passive real estate income to contribute directly to their student’s future. Students who are fortunate enough to receive funds this way have the added advantage of starting their careers with little—or even no—debt.

Choosing a College Savings Account

To review, the primary difference between the two most common types of college savings accounts is how free you are to invest in different things. The Coverdell allows for a variety of investment options, but the money isn’t tax deductible. On the other hand, the 529 plan may allow you to take advantage of a tax deduction if you live in an eligible state. But the trade-off is that you won’t have as many choices about what types of investments the account can hold.

If you have children, are you prepared to help them pay for their college education? What type of account do you use currently, and do you believe that’s the best choice?

Let’s talk in the comment section below. 

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.