According to the Securities and Exchange Commission: "A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs." Many work like a 401(k) or an individual retirement account (IRA) by investing your contributions in mutual funds or other investments. The funds placed in these accounts are not subject to taxation (the name refers to "529" of the Internal Revenue Code, which created these shelters in 1996). The savings in these accounts can be applied to tuition of all colleges in the United States, regardless of location. All states have at least one 529 plan in place, each with its own features and benefits. Some plans also allow you to prepay all or part of an in-state public college education.
Previously known as an "Education IRA," the Coverdell Education Savings Account (ESA) lets households contribute up to $2,000 a year to the fund. While the contributions themselves are not tax deductible, the earnings can be withdrawn tax-free and can pay for other types of educational expenses than tuition (e.g., room and board). The account allows not just immediate family but friends, grandparents and godparents to contribute to the fund. Bear in mind that this fund may only be used for individual contributors who earn less than $110,000 per year or households less than $220,000.
A Uniform GIfts to Minors Act (UGMA) account is a custodial account that allows the gifting of assets to minors. This type of account can be useful for avoiding the estate tax as well as the parents' usual income tax rate. However, this option has declined in popularity because it has become a negative factor in how colleges determine financial aid packages. Unlike other college savings accounts, money from this account may be used for purposes unrelated to education.
U.S. savings bonds purchased after 1989 may be cashed in tax-free when applied to college tuition and fees. However, these bonds do not accrue value as aggressively as 529 plans and Coverdell ESAs. As a last result, Roth or traditional IRAs may be used, but cashing out may leave insufficient funds for retirement.