ESA vs 529: An Explanation


ESA vs 529 Explanation-900

When thinking about starting an ESA vs 529 Plan the main difference is that an ESA is a trust and a 529 is a savings plan.

An Education Savings Account or ESA is a custodial or trust account into which money can be invested for the future educational costs of the beneficiary or person whose name is on the account.

A 529 Plan is a savings plan for future educational expenses that comes with tax advantages, and also involves investing the money in a portfolio. 

The legal term for a 529 plan is a  “qualified tuition plans,” are there are two options for saving:  education savings plans and prepaid tuition plans.

When my family and I were saving for my college education, we used a 529 plan.  However, I didn’t initially understand what that was, or what the difference between ESA vs. 529 Plan was.

While these two programs are similar and both are common, there are important differences to be aware of when choosing where to put your money. These important differences between ESA vs. 529 Plan will help determine your needs while one saves for college.

  

ESA vs. 529 Plan: How do they differ?

The main difference between these two types of 529 plans is that education savings plans allow individuals to save for both tuition and room and board, and prepaid tuition plans only allow saving for tuition. 

Prepaid tuition plans are becoming less popular, and are offered in only a few states now.  

For both ESAs and 529s, non-qualified educational expense withdrawals are eligible to be taxed and receive a federal fee of 10%. 

Neither account will significantly hurt an individual’s chances of receiving financial aid through FAFSA. 

For both, the beneficiary can be changed within the family, so if the beneficiary received a full-ride scholarship, the money could go to their children or other relatives. 

Additionally, both 529 plans and ESAs are “after-tax” accounts, which means that while they aren’t deductible from your taxes at the end of the year, the money is not taxed unless it is withdrawn for non-educational purposes.  

ESA vs. 529 Plan: Things to Note

  • ESAs can be used for elementary and secondary education without limit, and 529s can only contribute up to $10,000 to elementary and secondary education. 
  • You can only contribute up to $2,000 a year to an ESA (only up to $36,000 over 18 years), and with 529s you can contribute up to $14,000 every year (up to $250,000 over 18 years).  
  • 529 plans have no income restrictions for contributors, but with ESAs contributors can only make up to $110,000 a year if single and $220,000 if married. 
     
  • ESA money can be invested in a wide range of things, but 529s are always an investment portfolio. Overall, 529 Plans are more restrictive about where the money can be invested and how often you can make changes. 
     
  • ESA funds have to be distributed by the time the beneficiary is 30 years old, 529 plans have no age no limit. 
  • Some 529 Plans qualify for state tax benefits, but most ESA accounts do not. 
  • 529s are more popular these days, though both can be good options depending on your situation. 

ESA vs. 529 Plan: Considerations

An ESA or 529 is typically started by the parents or guardians of the beneficiary who will utilize the money. 

Both programs protect the money from federal taxes and legally place the money in the hands of the beneficiary.  Both programs can offer significant returns on initial investments, ranging from 2-10%.  

The cost of college tuition currently averages around $35,000 for private universities, $10,000 for state residents at public universities, and $25,00 for out-of-state residents attending public colleges, excluding room and board. 

Therefore, totaling room and board and tuition over four years can easily add up to as much as $200,000.  An ESA or 529 can help families save more to adjust for these increasing costs.  

529 Plan Details

529 Plans are the most popular choice for saving for college educations today.  Make sure to review the fees and limitations before deciding for sure:  

529 Plan Fees 

Different plans have different fee amounts, so review the specific fees for your options before making a choice. However, common fees include the following:  

  • Enrollment Fee (some plans): around $50  
  • Annual Maintenance Fee: $10- $25 
  • Administration/Management Fee:  Typically a small percentage of the amount in the plan, charged annually.  A small difference in this annual fee can make a big difference over time, so do the math and think ahead before committing to a plan with a high annual management fee.  
  • Deferred Sales Charge (some plans): A small percentage charged when you withdraw from the plan, typically around 2.5%. See your plan options for specifics.  

529 Plan Limits and Restrictions 

  • Annual contributions are capped at $14,000, and most plans cap the total contributions over time at $250,000.  
  • The investment portfolio is often controlled by a professional, though you have some choice when you open the account.  
  • Money can only be moved from one investment to another twice a year.  
  • Money that is withdrawn for nonqualified expenses will be taxed and you will pay a 10% fee. 

Qualified 529 Expenses include:

  • Tuition and fees 
  • Room and board (on or off campus) 
  • Books and other supplies 
  • The technology used for school, such as laptops 
  • Common expenses that are not qualified include application and testing fees, transportation, medical expenses, and insurance.  
  • You do not have to invest in the 529 Plan in your home state, or the state of the school the beneficiary will attend.  It does not matter which state plan you choose.  
  • As of recent tax changes, 529 Savings Plans can be used to pay for K-12 expenses, up to $10,000 per year for the named beneficiary. 
  • Most 529 Plans technically have to be owned by an individual, so if you are married you cannot own one together. 

When you’ve reviewed the fees and rules and are ready to open a 529 plan, you must make decide several factors in order to choose a specific plan:  

  • Choose between the savings plan and the prepaid tuition plan.  
  • Choose whether you’ll select an in-state or out of state plan.  If your state offers tax benefits, you’ll probably want to do the in-state option.  You can look at options here
  • There are over 100 options for investment plans, so spend some time combing through the specific options and choosing the one that fits your budget.  

When you’re ready to decide on a specific 529 plan, run it by a financial advisor and get started saving!  

How to Apply for an ESA  

You can peruse plans and apply for an Education Savings Account through most banks, credit unions, brokerage or mutual fund accounts. 

Just like with 529 plans, there are many different options to consider, and fees, limits and restrictions to review.    

ESA: Fees 

  • ESAs have similar fees to 529 Plans, and just as with 529 Plans, you should compare the specifics of all your options before choosing one.  Fees can include enrollment, management fees, and withdrawal fees.  

ESA: Limits and Restrictions 

  • Annual contributions cannot exceed $2,000. 
  • Individuals with incomes over $110,000 and joint-filers with incomes over $220,000 are ineligible to contribute to ESAs.  
  • The funds must be distributed by the time the beneficiary turns 30, or be transferred to a member of the beneficiary’s family before they turn 30.  Special needs beneficiaries can waive this rule.  
  • Money that is withdrawn for nonqualified expenses will be taxed and you will pay a 10% fee.  

How does an ESA vs 529 affect my taxes? 

Contributions are not tax-deductible, but the growth isn’t taxed, and withdrawals are not taxed as long as they are used for qualified educational purposes.  Non-qualified withdrawals are subject to income tax and an additional 10% fee.  

Tips and Tricks 

If you’ve decided to invest in an ESA vs 529, make sure to consider the following tips:  

  • Review and plan for the fees in advance.  You don’t want to be surprised by fees when you get close to withdrawing for college.  
  • Think carefully about choosing a prepaid tuition plan, and under the restrictions before doing so. There are no guaranteed returns, and they don’t cover room and board.  
  • 529 plans have a “gift tax” exclusion that allows other people, such as grandparents, to contribute to the plan tax-free.  
  • Don’t withdraw money before accounting for scholarships.  If you withdraw for more than the qualified expenses, you’ll be taxed and fined 10%.  
  • Don’t forget to adjust your portfolio over time–what you invest in when the beneficiary is one year old might not still be a profitable investment when they are 17.  
  • Plan ahead and begin contributing as soon as possible: there will be more returns and you’ll have more time to save if you start early.  

ESA vs 529 Plan Conclusion 

If you’ve read through this article, you’re one step closer to saving for college! Research is an important step in deciding between an ESA vs 529 and beginning the saving process.

Whether you’re the parent of a new baby, a student looking ahead, or a parent looking so ahead you don’t even know the name of your beneficiary yet, you’re making good progress. Good luck!  

For more reading on how to apply for loans and scholarships read here.

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