My sister-in-law told me the other day that she and her son’s father were interested in establishing some type of savings/investment account for her son’s future, meaning more than likely college. She asked me what her options were and if I had any suggestions on the best path to take. At the time I told her I honestly didn’t know the best plan for her at the moment, but I’d probably recommend some sort of tax-advantaged college savings plan and that I’d look into the different options for her.
I did a little research and was reminded of the options: the Coverdell Education Savings Account and the 529 College Savings Plan.
Here’s the differences
I don’t want to go a lot into the minor differences between these two accounts, suffice it to say that the Coverdell Education Savings Account provides you a tax-advantaged way to save for college and other secondary education expenses (boarding school, etc) and can be invested in just about anything (mutual funds, stocks, bonds, cds, etc). The Coverdell Education Savings Account also has a $2,000 a year contribution limit. The 529 College Savings Plan is also a tax-advantaged way to save for college, but is more restrictive on what qualifies as an education expense (mostly just college tuition here, folks). The 529 plan doesn’t have a maximum contribution limit but often will have higher management fees (this plan is only professionally managed — no outside investing here).
That’s your rundown of the major differences between the two plans. So what’s right for your child(ren)? It’s definitely going to depend on your financial situation, especially your tax situation. Consult a tax advisor when choosing your options. Seriously. Some things are better left to the professionals.
How to open a college savings plan
All that being said, once you know which plan makes the most sense you’ll want to go ahead and open an account. If you like your bank/credit union check with them first to see what options they have. There’s a real good chance they’ll offer it in-house or refer you to a specialist near you that can assist with the process. If you don’t like your bank then don’t talk to them; go straight to one of the investment firms. If you’re eligible call USAA; they should be able to help you out with either the 529 or Coverdell. If you’re not military check with Fidelity or Vanguard to open a 529 account and Scottrade or Edward Jones for a Coverdell. There are certainly other options besides who I mentioned, so feel free to shop around for the option that makes the most sense for you.
If you are going the 529 route you won’t get much input on how the money is invested, so take what makes the most sense based on your timeline and leave it at that. If you are going the Coverdell route you’ll still want to consider how long the money will have to grow, and based on that choose your investments. If you’ve got longer than 5 years you’re probably better off with a higher-risk investment. Don’t make it difficult and don’t bother trying to beat the market. Just invest the money in an index fund and leave it alone. If your investment timeframe is less than 5 years you might consider investing part of the money in something a little more stable, so as to avoid losing any capital. CD’s, money markets, etc would work well here. An advisor at the company you are opening the account with can certainly provide more insight on what investments make sense.
That’s really about all there is to it. Hopefully this will be helpful to those of you who are interested in opening some sort of college savings plan for your children. Let me know if you have any questions in the comments below, or feel free to shoot me an e-mail.