A 29 account is a custodial savings account set up by a parent or guardian to save money for a child's education expenses

The formal name is a Coverdell Education Savings Account, but it is commonly called a 29 account because of the section of the tax code that created it. You open it at a bank, brokerage, or credit union in the child's name, with an adult as the custodian. Money you put in grows tax-free as long as you use it for education costs — tuition, room and board, books, computers, and K-12 private school tuition all count.

The main trade-off is the contribution limit: you can only put $2,000 per child per year into a Coverdell account. That is much lower than a 529 plan, which has no annual limit (though there are aggregate limits that vary by state). If you are saving for college and want to put away more than $2,000 a year, a 529 is usually the better choice. If you are saving smaller amounts or want more control over the investments, a Coverdell may work for you.

Key Takeaways

  • A Coverdell account lets you contribute up to $2,000 per child per year, and the money grows tax-free if used for education.
  • You can use the money for K-12 private school tuition as well as college, which 529 plans do not always allow.
  • The account must be opened before the child turns 18, and all money must be withdrawn by age 30 or you will owe taxes and penalties on the earnings.
  • If the child does not use all the money for education, you can transfer the unused balance to a sibling's Coverdell account without penalty.

How money grows in a Coverdell account

When you open a Coverdell, you choose how to invest the money — stocks, bonds, mutual funds, or cash, depending on what the financial institution offers. The earnings (interest, dividends, capital gains) are not taxed as long as the money stays in the account. This is called tax-free growth.

You do not get a tax deduction for putting money in, the way you might with some 529 plans or retirement accounts. But because the growth is tax-free and the withdrawals are tax-free (when used for education), you end up ahead compared to saving in a regular account where you would owe tax on the earnings each year.

What counts as an education expense

You can withdraw money from a Coverdell without penalty for tuition and fees at any school — public, private, or religious — at any level from kindergarten through graduate school. Room and board at college counts if the student is at least a half-time student. Books, supplies, computers, and required equipment also count.

K-12 private school tuition is a major advantage of Coverdell accounts over 529 plans. If you are paying for private elementary or high school, a Coverdell is often the better tool because 529 plans have only recently begun allowing K-12 withdrawals, and many state plans still do not.

Age limits and withdrawal deadlines

You must open a Coverdell account before the child turns 18. Once the account is open, you can keep contributing until they turn 18, but no later. The hard deadline is age 30: all money in the account must be withdrawn by December 31 of the year the child turns 30, or you will owe income tax plus a 10 percent penalty on any earnings that remain.

This is a real constraint if the child does not go to college or does not use all the money by then. A 529 plan has no age limit, so money can sit there indefinitely. If your child is already a teenager and you are just starting to save, the Coverdell window is closing, and a 529 might be the better choice.

What happens if money is left over

If the child receives money from a Coverdell and does not use it all for education in that year, you can roll the unused amount into a 529 plan for the same child without tax or penalty. This is a useful escape hatch if the child gets a scholarship or decides not to go to college.

You can also transfer unused money to a Coverdell account for a sibling (or other family member under age 30) without penalty. The money keeps growing tax-free in the new account. If you do neither of these things and simply withdraw the leftover money, you will owe income tax on the earnings portion plus a 10 percent penalty.

Coverdell vs. 529: which one to choose

A Coverdell makes sense if you want to save for K-12 private school, if you are saving smaller amounts (under $2,000 per year), or if you want more control over how the money is invested. A 529 makes sense if you want to save larger amounts, if you are saving only for college, or if you want to keep the money in the account past age 30.

Many families use both: a Coverdell for K-12 expenses and a 529 for college. You can contribute to both in the same year as long as the total does not exceed the 529 aggregate limit, which varies by state but is usually in the range of $235,000 to $550,000 per beneficiary.

How to open a Coverdell account

You can open a Coverdell at most banks, credit unions, and brokerages. You will need the child's Social Security number, your own identification, and the child's date of birth. The account is held in the child's name with you listed as the custodian.

There is no federal application process — you simply open it like any other savings or investment account. Some institutions charge annual fees; others do not. Compare the investment options and fees before you choose, because you will be holding the account for years and small fees add up.

Frequently Asked Questions

Can I open a Coverdell for a child who is already 18?

No. The account must be opened before the child turns 18. If your child is already 18, a 529 plan is your only tax-advantaged education savings option.

What happens if my child gets a scholarship?

You can withdraw the scholarship amount from the Coverdell without the 10 percent penalty, though you will still owe income tax on the earnings portion of that withdrawal. You can also roll the money into a 529 or transfer it to a sibling's Coverdell.

Can I use Coverdell money for student loan payments?

No. Student loan repayment does not count as a may have access to education expense. You can only use the money for tuition, fees, room and board, books, and equipment while the student is enrolled.

Does a Coverdell affect financial aid?

Yes. Money in a Coverdell account is counted as an asset when calculating financial aid may be able to access, which may reduce the amount of aid the student receives. A 529 plan owned by a parent has a smaller impact on aid calculations than a Coverdell.

Can I change the beneficiary of a Coverdell to a different child?

Yes, you can change the beneficiary to a sibling or other family member under age 30 without tax or penalty. This is useful if one child does not need the money and another does.