Coverdell vs. 529 Educational Savings Plan

I suspect that there's something the T. Rowe Prices and TD Waterhouses of the world don't want us to know because I'm having trouble decyphering the institution-speak when I look into these education savings plans on their web sites. There seems to be a distinct lack of information / misinformation on some aspects of educational savings plans, and it's bugging me.

I suspect that because the big institutional investors want your unthinking business, they tend to talk up the 529 plans, which appear to be mostly poor-performing mutual funds. They get your money, skim their vig off the top, and give you some crappy return. The Coverdell plan is far better for someone who believes they can beat the average market return (minus load) that the 529 plans typically offer. The gotcha is that the Coverdell plan is limited to $2000 in annual contributions (and parental income is capped for eligibiltiy, though sadly I don't earn enough to have that apply). The 529 plan offers what is in practice unlimited annual contributions and no cap on parental income levels. Both types of funds grow without taxes on earnings, but the Coverdell has the advantage in terms of the breadth of the expenses that can be paid out of it: It can be used for many school-related expenses even in grades K-12, whereas the types of expenses that qualify for the 529 are more limited. To me it seems that the information readily available at the big institutional investors has a built in bias to herd the unsuspecting towards the 529 plans. Clearly, that type of investing situation is set up to favor the big institutional investors (at your expense).

On the other hand, either type of educational savings plan is better than any other legal alternative, so at some point you need to make a decision.

Here are the questions to which I have not yet found answers: (EDIT1 - I have answers now, indicated below, courtesy of a web site that is not affiliated with a big institution.)

  1. Can one have both a Coverdell (which one would use up to the contribution limit each year) as well as a 529 (which one would settle for as a second best investment)? I suspect the answer is yes, but no one seems to discuss this option since from the big institution's point of view. From the 16th stroy corner office, it's far better to effortlessly make 3% annually off the top of a giant, no-brains, mutual fund than to make $12.99 only once when the Coverdell owner makes a trade. Answer: Yes. As of 2002 you can have both.
  2. Can a child contribute to his own Coverdell (in addition to the parental input of $2000)? If yes, then this suggests that there is a way around the contribution limit. Answer: No. See this web page. Total contributions are always capped at $2k, but the child can contribute his or her own money to avoid parental income caps.
EDIT2: It's clear that the very best invesment strategy is a Coverdell until it's maxed (which you will invest prudently in the market), then the remainder of what you can afford in a 529. I'll be doing this soon.

EDIT3: Hot on the heels of writing this, I received my every-so-often glossy magazine from T. Rowe Price where they did lay out some information on both Coverdell ESA and 529 plans. However, I don't recall mention that you can captain your own ship with the Coverdell plan nor that you can use both plans.

1 comment:

  1. Check this out: