If you’d like to save for your child’s future higher education expenses while also reducing your tax liability, consider opening a 529 plan. They come in two basic varieties: the college savings plan and the prepaid tuition program. Both are easy to set up and offer the same tax advantages.

College Savings Plan
Every state has at least one 529 savings plan available. You may use whichever state’s plan you like, and can use the money you save and invest at any accredited college or university in the United States.

Each state’s college savings program offers several different investment choices, so shop around for the plan that best meets your financial and educational needs. For example, some begin with aggressive investments and gradually become more conservative. Others offer a “guaranteed option” which protects your principal, but also provides for some investment growth.

Prepaid Tuition Plan
Prepaid tuition plans allow you to buy all or part of a public in-state education at today’s prices. The value of the investment is guaranteed to at least meet college tuition inflation. This can give you a lot of peace of mind. The plans offer a better rate of return than savings accounts and certificates of deposit, involve no risk to principal, and often are guaranteed or backed by the state.

Pre-paid tuition plans are offered by individual states (although not every state has one). The tuition guarantee is based on an enrollment-weighted average of that state’s public college tuition rates. Therefore, if your child does go to an in-state public college, the plan will cover his tuition and fees. However, if he attends a private or another state’s public college, the plan will pay the average of the in-state public college tuition. In other words, you won’t lose the money, but there may not be enough to cover the new institution’s cost. In that case, you’ll have to come up with the difference.

Tax Advantages – and Drawbacks 
With both college savings and prepaid tuition plans, as long as you use the investment for qualified education expenses, you won’t have to pay income tax on the earnings. For the savings plans, qualified expenses include tuition, books, supplies, and room and board if the student is enrolled at least half time. In contrast, the prepaid programs typically just cover tuition and room and board. If you use your own state’s plan you may also qualify for a state tax deduction. Your contributions, however, are not deductible on your federal tax return.

If you take any money out for non-educational purposes, the earnings portion of the “non-qualified” withdrawal will be subject to income tax, and you’ll have to pay a 10 percent penalty tax. Some states even add an additional 10 percent penalty for early withdrawal.

If Your Child Doesn’t Need or Use the Money
If your child does not end up going to college, you can change the beneficiary to another qualifying family member who will go. Doing so will enable you to avoid the expensive penalties for non-qualified withdrawals. Also, if your child receives a scholarship and doesn’t need all or some of the funds that you saved in the plan, you won’t be penalized for the remainder of the money you withdraw.

Be aware that if the person for whom the account was originally intended dies or becomes disabled (and you don’t transfer the account to someone else), you will not be charged the penalties when you terminate the account and withdraw the funds.

Who Can Use 529 Plans
Everyone is eligible to take advantage of a 529 plan. There are no income limitations or age restrictions. While most people use these plans to save for their children, you may use them for anyone, including yourself.

529 Plan Management
One of the advantages of a 529 plan is that you don’t have to do much to manage the account. Either the state treasurer’s office or an investment company that is hired as the program manager does that for you. All these professionals come with a price though: management and fund fees can be high, and in some cases even outweigh the plan’s benefits. Also, several plans charge one-time enrollment fees, which range from $10 to $90.

How to open a 529 plan
To know what each state is offering and to compare and contrast plans, visit the College Savings Plans Network’s website: www.collegesavings.org, or Savingforcollege.com at www.savingforcollege.com. Many financial institutions offer information about 529 plans, and the option to enroll in the plan with them as well.

After you decide which 529 plan to use, you just need to complete a simple form and make your first contribution – which can be as low as $25. Be sure to sign up for automatic deposits to make savings easy.

Saving for college with tax-advantaged investment vehicles makes good financial sense. Higher education can be a major expense, and saving and investing early will help you achieve this goal efficiently.