529 plans were authorized by Congress in 1996. They are administered by the states and provide families with tax incentives to encourage saving for college. States implement their 529 plans in various ways, with each having its own conditions, but all 529 plans are exempt from federal income tax.

529 Prepaid Tuition Plans are offered by 19 states. These plans lock in the price of tuition at today’s rates, no matter what the rate actually is when your child enters college. Prepaid tuition plans are operated by state governments. If you decide to invest in a prepaid tuition plan, your college savings will go to the state, either in a lump sum or in monthly installments. The state, in turn, will invest the money to earn the difference between what you’re paying and the projected cost of tuition when your child reaches college age. Accounts are guaranteed by the state government to at least match in-state college tuition increases. Check with your state’s commission on higher education to see if a prepaid tuition plan is available where you live.

Anybody can contribute to a prepaid tuition plan. This is especially good for grandparents, because of the estate planning possibilities. Prepaid tuition plans are exempt from federal income tax, and, in some states, from state and local income taxes.

Prepaid tuition plans are not for everyone. Using this option may jeopardize your chances for state financial aid if you would otherwise qualify. If you’re interested, and a plan is offered in your state, determine:

• Whether the plan covers only the cost of tuition, or room and board, as well;
• If you can apply the proceeds to another state school within your state; and
• How your original deposit will be returned if your child does not attend college or attends a private or out-of-state college.

529 College Savings Plans. Unlike prepaid tuition plans, these plans do not lock in tuition rates and make no guarantees. The value of investments in these plans will fluctuate based on the investment vehicles you choose and market conditions; savings may not be enough to cover all college expenses. Most 529 Savings Plans offer a variety of investment options based on the number of years until the funds are needed.

The maximum permitted account balance (per beneficiary) will be specified by the plan you choose and the state in which you live. Some plans have a dollar amount limit — usually $300,000. Limits on others are tied to the projected (future) cost of full-time college tuition for five years. Additionally, most—but not all—will have annual contribution limits.

Contributions may be made by parents or by others (e.g., gifts from grandparents). In 2008, $12,000 per donor for each beneficiary is eligible for the gift-tax exclusion. Note that other gift-tax considerations may apply. To determine specific laws and regulations that affect your situation, consult a financial professional.

Unlike prepaid tuition plans, the monies from the account may be used at any qualified institution of higher learning within the United States. If your child does not go to college, the money can be used for another family member’s qualified education expenses or you may keep the money and be taxed at your ordinary income rate plus a 10 percent penalty. Check with your state’s commission on higher education to see if a college savings plan is available where you live. If your state does not have a savings plan, many other states have opened their plans to non-residents. You should consider the potential tax benefits (if any) that your own state’s plan offers to residents prior to considering another state’s plan. A 529 plan locator to determine the plan(s) available in your state is at The College Savings Plan Network.