For years, Coverdell Education Savings Accounts have offered a relatively hassle-free alternative to state sponsored 529 plans. But come 2011 Coverdells will lose some of their luster, and some families may want to spend their Coverdell savings quickly or shift them to a 529.

Both plans allow families to earn tax-free returns on investments used for education. But the Coverdell could be used to pay for K-12 school expenses as well as college, while the 529 plan is restricted to higher education. After this year, Coverdells will be limited to college expenses too.

Another key difference: Coverdells have been simpler. They operate much like IRAs, allowing virtually unlimited investment choices, while 529 investors are limited to options offered by the states. This feature won’t change, but Coverdells will become less useful because the $2,000 annual limit on contributions will drop to $500 on Jan. 1. There are no annual contribution limits with 529 plans, and many have lifetime limits in the hundreds of thousands of dollars.

Of course, Congress could amend the new rules before year-end, but there’s no sign that will happen.

Families who want to use Coverdell assets for private primary and secondary schools should consider doing so while they still can — for this fall’s expenses.

There’s no need to do anything if you plan to use your Coverdell for college expenses. But because the Coverdell contribution limit will drop, a 529 may be more appealing if you plan to continue making contributions. In that case, an existing Coverdell can be a good source of funds for opening a 529 plan.

Each state offers one or more 529 options, and most states do not require that either the contributor or the beneficiary be a state resident, unless the investment is in a 529 subset called prepaid tuition plans.

However, some states offer tax deductions on contributions made by residents, and a few offer deductions on contributions their residents make to other states’ plans. There are no federal deductions on contributions, though investment gains are tax free if used for qualified expenses. Many states exempt withdrawals from state tax.

Morningstar Inc., the market-data firm, says the best plans are found in Ohio, Indiana, Utah and Virginia. Morningstar also has data on individual plans.

The process of moving money from a Coverdell to a 529 is fairly simple, according to Once you choose a 529 plan, take a distribution from the Coverdell, then put an equal sum into the 529 during the same calendar year. Inform the 529 plan trustee that the funds are coming from a Coverdell rollover.

Unfortunately, there is no way to make a trustee-to-trustee transfer as there is when you move money from a 401(k) to an IRA or from one IRA to another. So you will have to tell the Coverdell trustee to send the money to you. Be sure to keep all paperwork so you can handle any IRS questions and avoid a tax bill and 10% penalty on unqualified distributions.

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