A 529 plan is a type of tax-advantaged savings plan for college tuition described in the IRS code section 529, which explains their name. They are also referred to as “qualified tuition plans.”

These plans can have tax benefits depending on your state that include deductions of contributions from your income and matching state grants. The earnings on the investments are not subject to federal tax, and usually not state tax, when they are used for qualified higher education expenses.

You should know that the assets in a 529 plan will be included on a parent’s Free Application for Federal Student Aid (FAFSA), which may decrease your child’s eligibility for need based student aid.

If you think your child might qualify for need based aid when they start college, consider having a grandparent open the 529 with your child as the beneficiary so the assets don’t have to be included as child or parent assets on the FAFSA.

It is only counted in the child’s asset/income after they have received distributions, so it’s also advisable to wait to take distributions until the junior and senior years of college because the FAFSA uses previous years of income that wouldn’t include the 529 distribution yet.

If the parent owns the 529 with the child as the beneficiary, it will be included in the parents assets for all years since the parents’ assets are considered for determining aid but grandparents’ assets are not.

Also as a side note, the parents’ primary residence and all retirement accounts are excluded from assets considered on the FAFSA.

These investment plans do have fees and restrictions, so you should look for plans that have low fees and should review any restrictions.

If you withdraw the money for anything other than qualified expenses, you would have to pay taxes as well as a penalty.

You should check to see if your state offers benefits for contributions to a 529 plan. Keep in mind that you can sign up for plans from any state, regardless of which state you live in.  (But, state benefits may not apply to out-of-state plans.)

Each state administers their own 529 plan with different investment options and fees. It is kind of like different investment companies offering different mutual funds. You can choose the state with the options that best fit your needs.

You can find more information and compare plans at SavingForCollege.com.