An education savings account lets you set aside money for school costs and get a tax break on the growth

An education savings account (ESA) is a tax-advantaged account where you deposit money to pay for education expenses. The money you put in grows tax-free, and when you withdraw it to pay for school costs, you do not pay taxes on the growth. The main types are Coverdell ESAs (federal accounts) and state-sponsored 529 plans, though the rules and limits differ between them.

The basic idea is simple: you contribute money, it sits in an investment account and grows, and then you pull it out to pay tuition, books, room and board, or other school-related expenses. Because the growth is not taxed, you end up with more money available for education than if you had saved the same amount in a regular savings account.

Key Takeaways

  • Coverdell ESAs have a $2,000 annual contribution limit per child but let you invest in almost anything; 529 plans have much higher limits but restrict investments to mutual funds and similar options.
  • Money grows tax-free and withdrawals for school costs are not taxed, but withdrawals for non-education expenses trigger taxes and a 10 percent penalty on the earnings portion.
  • You can use ESA funds for K-12 private school tuition and expenses, college tuition and fees, room and board, books, computers, and some room and board costs at graduate school.
  • Coverdell accounts must be opened before the child turns 18 and funds must be spent by age 30, while 529 plans have no age limits and can be transferred to other family members.
  • The account owner (usually a parent) controls the money and decides when to withdraw it, not the child.

Coverdell ESAs versus 529 plans

A Coverdell Education Savings Account is a federal account with strict limits but flexible investment choices. You can contribute up to $2,000 per child per year, and the money can be invested in stocks, bonds, mutual funds, or almost anything else your financial institution offers. The account must be opened before the child turns 18, and any remaining balance must be withdrawn or transferred by the time the child turns 30.

A 529 plan is a state-sponsored account with much higher contribution limits—often $235,000 or more per child, depending on the state—but your investment choices are limited to the plan's menu of mutual funds and similar options. There is no age limit for opening a 529 or for using the funds. Many states also offer a state income tax deduction for contributions, which can save you money on your state taxes in the year you contribute.

The choice between them often comes down to how much you plan to save and whether you want investment flexibility. If you are saving a small amount and want to pick individual stocks or bonds, a Coverdell makes sense. If you are saving larger amounts or want the state tax deduction, a 529 is usually the better fit.

What counts as an education expense

You can withdraw money from either account to pay for tuition and fees at any school—K-12 private schools, colleges, universities, graduate programs, or vocational schools. You can also use the funds for room and board if the student is at least a half-time student at an accredited school, books and supplies, computers and internet access, and required equipment like lab materials or musical instruments.

For K-12 private schools specifically, you can use ESA or 529 funds to pay tuition directly. This is one of the main reasons parents open these accounts early—to lock in tax-free growth for private school costs that start in elementary school.

Withdrawals for non-education expenses are taxed as income, and you also pay a 10 percent penalty on the earnings portion (not the money you contributed). For example, if you withdraw $5,000 and $1,000 of that is growth, you pay income tax plus a 10 percent penalty on the $1,000. The $4,000 you contributed comes out tax-free.

How much you can contribute and when

With a Coverdell ESA, you can contribute up to $2,000 per child per year, and contributions must be made by the tax filing deadline (usually April 15). You can contribute to multiple children's accounts in the same year, but each child's account is capped at $2,000 annually. There is also an income limit: if your modified adjusted gross income exceeds a certain threshold (which varies by year), you cannot contribute to a Coverdell. For 2024, the phase-out begins at $110,000 for single filers and $220,000 for married couples filing jointly.

With a 529 plan, there is no annual contribution limit, though contributions are considered gifts for tax purposes. You can contribute as much as you want in a single year, but if you contribute more than $18,000 per person per year (in 2024), you may need to file a gift tax return. Many people spread large contributions over five years to avoid this. There is no income limit for 529 contributions.

How the money grows and when you can use it

Once you open an account and make a contribution, the money is invested according to the investment options available in that account. In a Coverdell, you choose the specific investments—stocks, bonds, mutual funds, or cash. In a 529, you choose from the plan's pre-built portfolios, which typically range from aggressive (mostly stocks) to conservative (mostly bonds), often with an option that automatically shifts to more conservative investments as the child gets closer to college age.

The money grows tax-free regardless of how much it earns. If your $2,000 Coverdell contribution grows to $3,500 by the time your child starts college, you do not owe taxes on that $1,500 gain. When you withdraw money to pay for school, the entire withdrawal—both your contributions and the growth—comes out tax-free.

You can withdraw money whenever you need it for education expenses. There is no requirement to wait until college; you can use Coverdell or 529 funds to pay for private K-12 tuition as soon as you open the account. You control when and how much to withdraw, and you decide which bills to pay with the money.

What happens to unused money

If money remains in a Coverdell ESA after the child turns 30, it must be withdrawn. Any earnings on that money are taxed as income, and you pay a 10 percent penalty on the earnings. The contributions themselves come out tax-free. This is why Coverdells work best for families who plan to use the money by the time the child finishes graduate school.

With a 529 plan, there is no age limit, so unused money can sit in the account indefinitely. However, the SECURE Act 2.0 (which took effect in 2024) allows you to roll over up to $35,000 of unused 529 funds into a Roth IRA in the child's name, subject to certain rules. This gives families more flexibility if their child does not use all the money for education.

You can also transfer unused 529 funds to another family member—a sibling, cousin, or even a grandchild—without penalty. This makes 529 plans useful for families with multiple children or for grandparents saving for grandchildren.

Who controls the account and how to open one

The account owner (usually a parent or grandparent) controls the money and makes all decisions about investments and withdrawals. The child's name and Social Security number are on the account, but the child does not have access to the money or a say in how it is invested. This protects the funds from being spent on non-education expenses.

To open a Coverdell ESA, you contact a financial institution—a bank, brokerage, or investment company—and ask to open an education savings account. You will need the child's Social Security number, your own identification, and proof of address. There is no federal application; each institution has its own process. You can open multiple Coverdell accounts at different institutions, but the total contributions across all accounts cannot exceed $2,000 per child per year.

To open a 529 plan, you visit your state's plan website or work with a financial advisor. Each state runs its own plan, though you can open an account in any state's plan regardless of where you live. Many states offer both a direct-sold plan (you open it yourself online) and an advisor-sold plan (you work with a financial professional). The direct-sold plans typically have lower fees. You will need the child's Social Security number and your own identification.

Frequently Asked Questions

Can I use education savings account money for student loans?

No. You cannot use ESA or 529 funds to pay down student loans. However, the SECURE Act 2.0 allows you to roll unused 529 funds into a Roth IRA, and you can use Roth IRA funds to pay student loans under certain circumstances. This is a newer option and the rules are complex, so check with a tax professional if this applies to you.

What happens if my child gets a scholarship?

If your child receives a scholarship, you can withdraw an amount equal to the scholarship from the ESA or 529 without penalty. You will owe taxes on the earnings portion of that withdrawal, but not the 10 percent penalty. For example, if you withdraw $5,000 and $1,000 is earnings, you pay income tax on the $1,000 but no penalty.

Can I change the beneficiary of my 529 plan?

Yes. You can change the beneficiary to another family member—a sibling, cousin, niece, nephew, or even a grandchild—without penalty or tax consequences. This is one reason 529 plans are popular for grandparents; if one grandchild does not use all the money, it can go to another family member's education.

Do education savings accounts affect financial aid?

Yes, but the impact depends on who owns the account. Parent-owned 529 plans and Coverdells are counted as parent assets on the Free Application for Federal Student Aid (FAFSA), which reduces aid may be able to access by up to 5.64 percent of the account value. Grandparent-owned accounts are not counted on the FAFSA, but distributions from them are counted as student income in the following year, which can reduce aid more significantly.

Can I open an education savings account for a grandchild?

Yes. Grandparents can open either a Coverdell ESA or a 529 plan for a grandchild. With a 529, you can contribute large amounts and take advantage of the five-year gift tax election. With a Coverdell, you are limited to $2,000 per year, but you have more investment flexibility. Grandparent-owned accounts do not count on the FAFSA, though distributions do count as student income.