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

by | BiggerPockets.com

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. A child’s parents or grandparents can contribute without limitations to a Coverdell until the child reaches age 18 if the contributor has income of $190k (if married and filing a joint tax return) or $95,000 (single). For all the high rollers out there, 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 per beneficiary (e.g. child or grandchild). The more contributors to the account, the more you can save.

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. Before you elect to use a 529 plan, be aware of its rules as well.

The Basic Rules of 529 Plans

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

  • Money can be withdrawn for tuition, fees, books, supplies, equipment, special needs, room and board.
  • There are no federal tax deductions or credits for contributions.
  • Up to $300,000 can be invested per beneficiary by any person. This means family members or anyone with an interest in your child can contribute, not just the parents.
  • Money is invested into a state run program.

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. Fortunately, this is currently available in 35 states. Do a little bit of research to see if your state is on the list. This deduction is not universal at this time. If you live in a state like California, you won’t be eligible for it.

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. While Coverdell accounts may only receive contributions of up to $2,000 from immediate family, anyone can contribute to your student’s account when you use a 529 plan. The overall contribution limits are far higher, as well, and may meet the needs of investors whose income limits exceed those outlined in the rules above.

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 of 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.

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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 towards 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 towards 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?

I hope this article has shed some light on the subject. If you have questions about college savings accounts or other investments, please don’t hesitate to ask them in the comments section below.

About Author

Scott Smith

Scott Smith helps clients nationally and internationally from his office in Austin, Texas. With over 5 years experience in the litigation, Scott works on proactively building defense in anticipation of future lawsuits for real estate investors. Scott is one of the few attorneys in the nation that structures companies for maximum protection with minimum taxes.

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3 Comments

  1. James Martin

    I think that the new tax law allows the 529 to beused for K-12 expenses starting in 2018. I know that Louisiana is having trouble getting the state law caught up with the federal code that allows this. I am keeping an eye on it.

    • Scott Smith

      Thanks for the info, James. You Louisiana folks and that wacky Napoleonic law (with all due respect to my LA investor-friends) operate a little differently. If any attorneys from LA wish to chime in, I’d love to hear from them too. Are you currently saving for a future student’s education?

      If you have a source on which K-12 expenses would be eligible, please feel free to share with us. Thanks for reading and commenting!

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