A Coverdell Savings Account and a state-sponsored 529 Savings Plan are both great ways to save for college. In both accounts, your earnings and withdrawals are tax-free when used to pay for eligible expenses. But they’re not identical. Here’s a rundown of the differences between them.

Am I eligible to contribute to the account?

  • The Coverdell account is available nationwide to single taxpayers who earn up to $110,000 a year and to married people filing jointly who earn up to $220,000. But Coverdell account contributions don’t have to be made with earned income. So even if a child’s parents are ineligible, an account can be funded with gifts from grandparents to minor children.
  • The Coverdell account beneficiary must be under 30 years old.
  • 529 plans are open to everyone. They have no income eligibility limits.
  • 529 plans have no age limit for beneficiaries. A 50-year-old could use a 529 plan to save for a return to college.

How much can I contribute?

  • In a Coverdell Account, the maximum 2010 contribution is $2,000 per child.
  • Most 529 plans have no annual contribution limit. The maximum lifetime contribution varies depending on the plan. Some plans allow you to contribute as much as $300,000 over the life of the account.

Do I get a tax break for contributions?

  • Neither Coverdell or 529 contributions are deductible on your federal income tax.
  • Coverdell contributions aren’t tax-deductible on your state income tax.
  • Residents can sometimes deduct 529 contributions from their state income taxes.

Where can I open the account?

  • You can open a Coverdell Account at any bank, mutual fund company, brokerage firm or insurer.
  • You have your pick of more than 70 state-sponsored 529 plans. Most 529 plans are available to investors nationwide, as well as to state residents. To learn more, go to www.savingforcollege.com, which gives details on every 529 plan in the U.S.

What investments are available to me for this account?

  • You can pick any investments you wish for a Coverdell Account.
  • Each 529 plan has its own menu of conventional mutual funds. Most plans also offer at least one fund that’s specifically designed for college investing, divided among stocks, bonds and cash according to the account beneficiary’s age. The mix becomes more conservative as the child gets older.

What expenses are eligible for tax-free treatment?

  • Coverdell distributions are tax-free when used to pay for education expenses from kindergarten through college. Eligible expenses include tuition, fees, tutoring, special needs services, books, supplies, computers, room and board, uniforms, transportation—and even extra services like extended daycare, if a school requires or provides them.
  • A 529 plan distribution is tax-free only if used to pay for tuition, fees, books and equipment required for study at a college or graduate school. (Any accredited college or graduate school in the U.S. qualifies, as do some foreign universities.) Eligible room and board expenses are limited to actual school charges for students who live on campus in housing that’s owned or operated by the school, or to whatever the school lists in its budget as an allowable expense for students living off campus. Room and board for students who live at home isn’t eligible.
  • In both cases, withdrawals that aren’t used to pay for eligible expenses are subject to income taxes plus a 10% penalty.

What if the child doesn’t go to college?

  • You can name a new beneficiary for the Coverdell Account, but he or she must be a member of the same family as the original beneficiary, and be under 30 years old.
  • If the 529 account beneficiary doesn’t go to college, you can designate another college-bound family member as the new beneficiary. There’s no age limit for beneficiaries, so any eligible family member could use the account to go back to school.

Which account is better for me?
They aren’t mutually exclusive. You can use both. It usually makes sense to contribute as much as you can to a Coverdell account—since it gives you the most investment freedom and the widest latitude for spending—and then open a 529 account if you have more to invest.