You do not pay state or federal tax on money invested in a 529 college savings plan. As long as you use the money to pay for a qualified college expense, you do not pay federal tax on withdrawals. In some states, you also do not pay state tax on withdrawals. Some states will even offer you a tax deduction for contributions you make to the plan.
You typically do not have to live in a state to open a 529 plan sponsored by that state. For example, if you like the terms California offers with the account but you live in New York, you can still open a 529 plan in California. There are also no minimum or maximum earning requirements to open a 529.
In some states, you can contribute up to $300,000 to a 529 plan. You also may be able to make a one-time $60,000 contribution to the plan without incurring a gift tax (a tax normally paid on gifts over $24,000).
When you open the account you need to name a beneficiary, but this can be changed as long as the new beneficiary is still a member of the extended family. That beneficiary can withdraw the money for any qualified college expense, including room and board, tuition or books.
In some cases you can participate in a 529 prepaid tuition plan. The difference from a 529 account is that you actually buy tuition credits for a particular group of public or private institutions within the state. In other words, you are essentially paying the tuition at the current market rate and getting tuition credits that the beneficiary can use to pay or offset the cost of attending any participating college.
If tuition goes up, your tuition credits are obviously worth more than what you paid for them, but you don't have to pay taxes on this appreciation. Furthermore, if the beneficiary decides not to attend one of the schools participating in the plan, you can often transfer the value of the tuition credits to other schools.
You may have to live within the state to participate in a state-sponsored 529 prepayment plan. Terms vary depending on the particular plan.
You can also establish an education savings account in your child's name in order to save for college. Your contributions to the account aren't tax-deductible. However, you do not have to pay taxes on earnings as long as the beneficiary withdraws the money before his 30th birthday to pay for a qualified educational expense.
If your modified adjusted gross income is $95,000 per year or less (single) or $190,000 or less (married), you are eligible to contribute up to $2,000 per child per year to an education savings account.
Money kept in an education savings account can be used in conjunction with other college savings accounts.