College Savings Educational Savings Account vs. 529 College Savings Plan

With a two-month old now inhabiting our house I decided to start looking at ways to save for college.

Educational Savings Account (ESA)
The ESA is also known as the Cloverdell Education Savings Account and the Education IRA. If your household income is under $200,000 year, you are able to invest up to $2000 per year per child in an ESA. The investment grows tax-free when used for higher education. Typically an ESA can be invested in any standard investment vehicle including mutual funds. Funding an ESA from birth until the child turns 18 with $2000/year and investing in a mutual funds averaging a 12% annual return will see that $38,000 invested resulting in $126,000.

529 College Savings Plan
The 529 plans are similar to the ESA with the investment growing tax free when used for higher education, however they offer more aggresive savings limits. There are also many state variations of the 529 Plan – usually this isn’t an issue but you should check your state rules and regulations to be sure. The downfall to the 529 is that you are locked into the investments of the plan administrator, which limits the amount of control you have over the investment of the money.

All things considered, I would recommend an ESA if you are starting the investment early in a child’s life. If your child is older and you need to agressively fund the account with more than the $2000/year then perhaps the 529 might be a better option.

Also note that if you are funding an ESA and want to invest more than $2000/year, there is nothing prohibiting you from opening both types of accounts. Fund the ESA first, then any extra can go into the 529.