Define your goals. 529 plans come in two forms: savings account and prepaid tuition. Using prepaid tuition, individuals purchase units that can be converted into credit hours at a public institution or contracts at institutions outside your home state. Prepaid plans are best suited for individuals who are adverse to risk. Under a savings account, individuals would funnel money into a mutual fund or other related investment vehicle. The account would fluctuate with market conditions---a viable option for those who can weather the investment market.
Choose a state. You're not confined to opening a 529 account in your state of residency. You may purchase an account where you live or in another state thousands of miles away. However, you will be eligible for a tax deduction if you open a plan in your home state. Approximately 32 states, and the District of Columbia, allow deductions for 529 contributions. Pennsylvania, Arizona, Maine and Kansas allow you to claim a deduction even if you are not a resident. Choose wisely.
Know the rules. Only 13 states operate prepaid tuition plans. What's more, funds must be used at public institutions. However, independent 529 plans are available in select states if you're interested in private universities. Prepaid tuition plans also protect you from future tuition increases. Savings accounts are generally more flexible. You're allowed to use the funds at a private or public university of your choice. Both plans are subject to strict penalties on unqualified withdrawals. Both plans are tax deferred, meaning you contributions are not subject to state and federal taxes. Nevertheless, you'll pay income taxes plus a 10 percent penalty if funds are used for non-educational expenses.
Think low fees. Check all the fees associated with opening and maintaining your account. Savings plans sold by brokers may be subject to a load fee---paid to broker for selling the plan. They also charge distribution fees that can amount to 1 percent of your initial investment. Direct sold savings plans allow you to avoid load fees. The plan is purchased from a state sponsor or fund manager.
Consider the implications. Both accounts will reduce your student's financial aid package. Prepaid tuition and savings account are counted as parental assets and can only reduce need-based federal aid by 5.64 percent.