ESA vs. 529—The Difference Between Education Savings Accounts and 529 Plans

Updated · Oct 21, 2022

Saving for your child’s education is crucial. If you choose a type of education savings account for that purpose, you can take advantage of tax-free withdrawals and investment growth.

There are several options available, but the most popular ones are ESAs and 529 plans.

Which one is better?

To answer that question, let’s examine the ESA vs. 529 pros and cons.

What Is a 529 Plan?

529 is a tax-advantaged savings plan for future education expenses.

It is sponsored by state governments and educational institutions and managed by investment companies. It gets its name from Section 529 of the Internal Revenue Code.

Contributions to a 529 plan are not deductible for federal income tax purposes. However, they may be deductible for state income tax purposes.

Just like a Coverdell education savings account, the 529 plan offers two major benefits:

  • Tax-free withdrawals for qualified education expenses
  • Tax-free growth

The qualified expenses of the 529 plan include:

  • Tuition and fees
  • Required supplies for university or an apprenticeship program
  • Room and board
  • Computer and internet access for educational purposes
  • Up to $10,000 to repay student loans

The possibility to repay student loans is a key advantage of 529 plans over an ESA fund. You can’t use the latter to repay your debt.

529 Rules

There are two types of 529 plans: prepaid tuition and college savings. 

The former lets you lock in fees at participating colleges and universities at today's prices.

The 529 savings plan also allows you to save for your child's future education. But instead of locking a fee, you can choose a predetermined investing portfolio so your money can grow.

Typically, the portfolio is a mix of mutual funds.

There’s no limit on 529 plan contributions. That said, if you surpass $15,000 a year, you will have to pay federal gift taxes.

529 Pros and Cons

Whether you choose 529 or ESA, your funds grow tax-deferred. Plus, withdrawals are typically tax-free if you use them for qualified expenses.

Before, 529 savings plans limited the use of money for higher education. But now, you can also use up to $10,000 for elementary and secondary education fees.

In addition, if the beneficiary decides not to pursue higher education, you may transfer the money to another recipient.

Unlike an ESA, 529 plans have no age limits on the use of funds. If the beneficiary decides to pursue higher education at the age of 40, they can still withdraw them tax-free.

Last but not least, you don’t have to use the 529 plan in your state. As every state offers a slightly different option, you are free to choose the one with the best conditions.

That said, there are also some disadvantages to consider before opening a 529 savings account.

For starters, withdrawal penalties apply if you don’t use the money for qualified education expenses.

Next, investment growth is subject to fluctuations in the stock market. Naturally, stock market investments can yield negative returns.

On the other hand, if you choose a savings plan, the account may not be at a loss when the beneficiary withdraws the money.

What Is a Coverdell Education Savings Account?

A Coverdell ESA is tax-advantaged savings account for educational expenses.

ESA stands for "education savings account." And Coverdell is the name of the Senator who helped create it.

Contributions to an ESA are not tax-deductible. Withdrawals for qualified expenses and investment growth are tax-free.

These include:

  • Tuition and fees
  • Required supplies for learning
  • Room and board
  • Computer and internet access for educational purposes
  • Up to $10,000 for K-12 school

When comparing Education Saving Account vs. 529, the main difference is that the former has more restrictions.

Let’s see some of them.

ESA Rules

An ESA has income limits, so it is suitable only for families with smaller earnings.

You can't contribute if you earn more than $110,000 (or $220,000 for a married couple filing jointly).

Another limitation is that you can put a maximum of $2,000 per child per year.

To avoid taxes and penalties, the beneficiary must use the money before the age of 30.

In the meantime, the owner can name someone else as a beneficiary.

ESA Pros and Cons

With an ESA, you get tax-free growth and withdrawals. What’s more, you can use the money for expenses related to both schools and colleges and universities.

But the main advantage of а Coverdell Education Savings Account vs. 529 is that it offers greater investment flexibility.

Still, there are some disadvantages to consider before opening an ESA.

First, the contribution limit is much lower than for a 529 plan.

Second, you can only contribute if your income is below a certain threshold.

And finally, the beneficiary must use the funds before they turn 30, or they will have to pay taxes and penalties.

ESA vs. 529—Which One Is Better?

So, let's see how Coverdell ESA performs vs. 529 one more time before we give our final verdict.

The two key advantages of a Coverdell Education Savings Account vs. 529 were the investment flexibility and the ability to use funds for K-12 schools.

In 2022, the latter is no longer valid, as 529 plans allow you to use the money for elementary and secondary school as well.

They also have more flexible uses of funds now. Plus, they have higher contribution limits and potential state tax benefits than education savings accounts.

So, ultimately, 529 plans are better than ESAs.

If you qualify, you can open both types of accounts to max out those benefits.

Wrap Up

Educational savings plans are the best way to save for your child's future.

Instead of leaving your money in a cookie jar until your child turns 18, you can put it in a secure account where it can grow over time.

But how to choose between ESA vs. 529?

After evaluating the benefits and restrictions of each, 529 plans come as better and more flexible than ESAs.

Aleksandra Yosifova
Aleksandra Yosifova

With an eye for research, Aleksandra is determined to always get to the bottom of things. If there’s a glitch in the system, she’ll find it and make sure you know about it.