Outside of retirement plans, there are other tax-advantaged accounts designed for people saving for education or for individuals with disabilities. This chapter covers:
Coverdell education savings accounts (ESAs) offer a tax-friendly way to save for a child’s education. ESA funds can be used for costs related to virtually any type of education, including grade school, middle school, high school, vocational school, and college.
An annual non-deductible contribution limit of $2,000 per child per year may be made into a Coverdell. Similar to Roth IRAs, contributions are non-deductible, and high-income earners (in 2025, $220k+ for a family) are prohibited from contributing. Contributions can be made until the child reaches age 18.
Once contributed, the assets are invested and grow tax-sheltered. Funds can be used when education-related costs arise. Coverdell distributions used to pay for educational expenses (called qualified expenses) are not subject to taxation. That’s the main advantage of these accounts: investment gains are typically taxable, but not in a Coverdell ESA (as long as distributions are used for qualified expenses).
If a withdrawal is not used for qualified education expenses, ordinary income taxes and a 10% penalty apply.
All assets in a Coverdell ESA must be distributed by the time the beneficiary reaches age 30. If the beneficiary doesn’t have educational expenses, assets can be rolled over into another family member’s Coverdell ESA, as long as the new beneficiary is under age 30.
529 plans, also known as qualified tuition programs (QTPs), are similar to Coverdell ESAs but are mainly used for college expenses. Each US state sponsors its own 529 plan.
Two general 529 plan types exist: prepaid tuition plans and college savings plans.
Prepaid tuition plans work the way they sound: investors contribute money for a future college student and “prepay” tuition at today’s rates rather than paying later (when tuition rates may be higher). These plans reduce the risk of rising college costs, which have risen much faster than inflation in recent years.
College savings plans involve investing in state-approved options, such as mutual funds. Investors typically have a range of choices, including everything from money market funds to aggressive growth funds. Many plans also offer target date funds, which are built around the year the funds are expected to be needed (for example, a 2040 fund for a student projected to attend college in 2040). Target date funds typically start more aggressive and become more conservative over time. Many eventually shift heavily into money market funds as the target date approaches.
Because saving for college is usually a long-term goal (especially for a young child), 529 plans limit frequent trading. The plan participant (the person managing the plan, discussed below) may make only two changes to the 529 investment allocation per calendar year. The plan participant can also move from one state’s 529 plan to another state’s 529 plan once per calendar year.
There are two parties in each 529 plan: the plan participant and the beneficiary.
The plan participant plays a role similar to a custodian in a custodial account. This is often a parent or other family member managing assets for a child. The plan participant’s responsibilities include selecting investments and requesting distributions when educational expenses occur.
The beneficiary is the person the 529 assets are intended to support, often the plan participant’s child or another close family member.
A key feature of 529 plans is the control the plan participant keeps. Assets placed into the plan remain the property of the plan participant, no matter how old* the beneficiary is. Unlike UGMA and UTMA accounts, there is no requirement to turn the assets over to the beneficiary once they reach adulthood. The plan participant is also not required to distribute the funds at all. If the child doesn’t go to college, there’s no requirement to give them the money.
*529 plans have no age requirement. Any adult can open a 529 account for a beneficiary at any age.
The plan participant also controls who the beneficiary is. Beneficiary changes can be made without tax consequences if the new beneficiary is a family member. The IRS considers the following as eligible family members for non-taxable beneficiary changes:
Contributions to 529 plans are made with after-tax money at the federal level. In other words, contributions do not reduce federal income taxes. However, some states provide a state tax deduction for contributions. The key word is some - several states do not offer a state tax deduction (especially those without an income tax).
Although contribution limits are not usually the main issue, gift taxes may apply. For the tax year 2026, a person gifting more than $19,000 to someone other than their spouse may be subject to federal gift taxes. For example, if a grandmother contributes more than $19,000 to her grandchild’s 529 plan, she may owe taxes.
There is a way to avoid gift taxes even when contributing more than $19,000. The IRS allows a one-time contribution of up to five times the annual limit. For example, a grandmother could contribute up to $95,000 ($19,000 x 5) to her grandchild’s 529 plan and avoid gift taxes. If she contributes anything more in the next five years, she would be subject to taxes.
Once funds are contributed and invested, the assets grow tax-deferred over time. The IRS cannot tax capital gains or dividends as long as the assets remain in the account. 529 plans generally require automatic reinvestment of capital gains and dividends.
529 plans do have contribution limits, but they vary by state, and you won’t need to know them for the exam. The limits are also quite high. For example, California’s cumulative contribution limit per person is $529,000. Also, 529 plans do not have phase-out rules, so high-income earners can contribute.
Recent changes to 529 plan distribution rules were enacted under the One Big Beautiful Bill Act (OBBBA), a federal law that expanded the definition of qualified educational expenses while preserving the tax-deferred growth and tax-free treatment of qualified withdrawals.
Distributions (withdrawals) are not taxable as long as the funds are used for qualified educational expenses. The definition of a qualified 529 expense is narrower than it is with Coverdell ESAs (where virtually all education-related expenses are qualified). Qualified 529 expenses typically include:
529 plans are primarily used for college expenses. However, up to $20,000 per year can be used for private, public, or religious schools below the college level*. K-12 qualified expenses are expanded under OBBBA to include books, curriculum and online materials, tutoring and educational classes, standardized test fees, dual-enrollment fees, and certain educational therapies for students with disabilities.
The expanded expense categories apply to distributions made after enactment; however, a 2025 reimbursement window allows distributions taken later in 2025 to reimburse earlier 2025 expenses that now qualify under OBBBA.
If college savings plan funds are not used for education, the account owner is subject to ordinary income taxes and a 10% penalty (only on the gains; the basis is always tax-free). However, if the beneficiary receives a scholarship and no longer needs the 529 plan, assets may be distributed without the 10% penalty (ordinary income taxes will still apply to gains). Generally, distributions must be taken in the same calendar year a college expense is assessed.
*When paying for educational expenses below the college level (K-12), qualified expenses are no longer limited to tuition. Under current law, certain additional K-12 costs may qualify, subject to annual limits. Nonqualified expenses remain subject to ordinary income taxes and a 10% penalty on earnings.
The Achieving a Better Life Experience (ABLE) Act of 2014 created what we now call ABLE accounts. Individuals with disabilities often face significant expenses, and ABLE accounts were designed to help pay for those costs.
ABLE accounts also provide a way for individuals with disabilities to save money without jeopardizing eligibility for certain government assistance programs. Many needs-based benefits, such as Medicaid, require beneficiaries to keep very low asset levels. If a disabled individual held substantial assets in a traditional brokerage account, they could become ineligible for those benefits. The ABLE Act allows individuals with disabilities to accumulate assets in a tax-advantaged account while generally excluding ABLE account balances from asset calculations for programs like Medicaid.
Contributions to ABLE accounts are made with after-tax dollars and are not deductible at the federal level, although some states allow a state income tax deduction. Assets are invested and grow on a tax-sheltered basis. Similar to Coverdell ESAs and 529 plans, distributions are tax-free if used for qualified expenses. For ABLE accounts, qualified expenses include medical expenses, housing, job training, and educational expenses.
To be eligible to open an ABLE account, the individual must have become disabled before age 46 (effective in 2026, increased from age 26 under the ABLE Age Adjustment Act). This eligibility expansion was enacted prior to OBBBA. The account itself does not need to be opened before age 46. For example, a 60-year-old individual who became disabled at age 44 would be eligible to open an ABLE account.
529-to-ABLE rollovers for disabled beneficiaries are now permanent, preserving tax-free treatment and avoiding the income taxes and 10% penalty that would otherwise apply to nonqualified 529 withdrawals. These rollovers must still comply with annual ABLE contribution limits.
The Roth IRA rollover option for unused 529 funds still exists, subject to applicable rules and limitations.
Registered representatives must disclose the potential loss of home-state tax benefits when recommending or using out-of-state 529 plans, including when advising on rollovers or coordination strategies involving ABLE accounts.
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