529 Plans

A 529 plan is an investment for education that is put aside in a mutual fund and grows in the account free of federal income tax. The money is withdrawn from the plan when the beneficiary is ready for college and is used for paying tuition and other school-related costs. Money invested in 529s can be used for a wide range of expenses beyond tuition, including books, supplies, computers, special-needs services and more.

There are two kinds of 529 plans:

Savings plan – This works like an IRA or 401(k) retirement account. You can invest in your choice of mutual fund without being penalized for taxes when you cash it in to pay for school.
Prepaid tuition plan – Offered by public universities, these allow you to make contributions toward tuition and fees at those schools over time. They can also be converted for use at schools in other states and private colleges. Some private schools also offer 529 plans.

The quality of these plans varies from state to state. Fortunately, you are free to invest in any state's plan, no matter where you live. And if you move to a new state, you can continue investing in the same plan. Most financial experts recommend looking first at your own state's plan to see what tax advantages, if any, are offered to residents. They may be significant enough to offset lower fees or better fund performance in other states' plans.

529 Eligibility
A 529 account does not affect the beneficiary's eligibility for financial aid. It remains an asset of the account holder and not the beneficiary. Though saved funds can be used for a variety of purposes, these purposes are regulated. Using funds for an unapproved purpose can incur taxes on withdrawals or a 10 percent penalty. Investors can start a 529 account for any child, regardless of income status, age, relation, or where they live. They are also able to change the beneficiary at any time. So if you start a 529 for yourself or one of your children who later decides not to attend college, you can designate that money to be used by any other college-bound child. The sooner you can start saving for college, the less your children will have to rely on expensive loans.

Be aware that when you contribute to a 529 plan, there may be a gift tax to pay if the contribution exceeds $13,000 a year.

Coverdell Education Savings Accounts
You can contribute up to $2,000 a year to a Coverdell education savings account for your child, as long as your income is under $190,000. These accounts can be opened with any financial institution and invested in anything from savings accounts to mutual funds.