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Originally Posted by leo06
I live in NJ and am looking for investments for my two year old. What are your experiences with either? Thanks for your input.
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As mentioned, the Coverdell contribution is capped at $2,000 per year per recipient, while the 529k has much higher caps, as high as something like $65,000 lump-sum covering a five year period and a maximum total contribution well into six figures (check online and official sources for details).
The major difference is that you can use Coverdell funds for both grade school expenses and higher education expenses, while you can use 529k funds only for higher education expenses.
Also, as mentioned, the contributor/custodian of the Coverdell account can direct the investments through a brokerage account. Income from the investments is federally tax free; not sure about state income taxes (I live in a state with no state income taxes, makes life that much less complicated). There is no guarantee that the investments will be successful.
In contrast, the 529k account usually, if not in all cases, must be given over to a professional money management company/manager who offers a menu of investment allocations for a fee, so you have to shop around for management companies/managers, allocations and fees; however, as alluded to, you may have to check specific state rules and state income tax rules to see whether any state income tax rules would apply if you choose a plan outside your home state. In any case, there is no guarantee that the investments will be successful.
About a dozen states also offer prepaid college tuition plans for the first four years of college. New Jersey is not one of them. In some cases of states which do, the state guarantees the plan outcome by law (unless the entire state and/or its college/university system go bankrupt), while others reserve the right to change or scrap the plan (with refunds I suppose).
Another option is a UTMA account, funds from which you
could spend on both private grade school and higher education expenses, or for any other purpose for the exclusive benefit of the beneficiary minor, up until the beneficiary's 21st birthday, at which time the beneficiary is no longer a minor and takes full title to any remaining funds. So for education expense purposes, this works best for private grade school expenses and the first three or four years of college. UTMA accounts enjoy some tax advantages, but once certain exemption levels are surpassed, they are fully taxable. The contributor/custodian can personally manage investments through a brokerage account, or even make direct investments in real estate and businesses; it is basically a trust fund as per state statute, more or less uniform throughout the country, for a minor, but with mandatory distribution upon attainment of majority age.
In my view, with interest rates so low and the contribution limits so low, the Coverdell is mostly useless since, even if you invest the contributions through a brokerage account, the sum hardly becomes significant until you reach around $10,000, so starting from the fifth year. On the other hand, you may be able afford only that amount and it is very simple to set up. It could be good if you start very early, as you seem to be planning to do. It may be possible to later roll over a Coverdell account into a 529k, but I'm not sure.
In any case, you could combine all three or four, depending on what's available, when you start, how much you can afford, whether the beneficiary will be attending private grade school, and to what extent you want to manage the investments, pay a manager, or insure an outcome. For example, Coverdell for early private pre-k and grade school expenses, 529k and/or prepaid college for undergraduate school, 529k for college expenses other than tuition and for graduate school, and UTMA to cover all bases up until the age of 21.
Hope this helps.
Good Luck!