A "529 Plan" is a savings plan established by a state or a college to help families save for college expenses. The plan has tax benefits that allow the savings you contribute for your child's college education to grow faster and go further. The name, 529, is a reference to the section of the Internal Revenue Code that established them in 1996.

Tax Benefits

A 529 Plan offers two primary tax benefits. First, the income from investments in the plan is not subject to tax while they are in the plan. Furthermore, if the money in the account is used for qualified educational expenses, the income can be withdrawn without paying any income tax. Given that the cost of a college education for children born in 2012 could reach $300,000, the interest earned on an account of that size would be significant - meaning that the tax benefits could be large.

Savings v. Prepaid Tuition

There are two kinds of 529 Plans. Some are savings plans that allow you to invest and earn a return with the accumulated savings available for use for college expenses at any school in the country. Prepaid tuition plans are offered by states and by colleges, allowing you to contribute money that effectively grows at the rate of inflation for college education at that school or in that state. Given that the cost of a college degree has been growing faster than general inflation for the last generation, it seems possible that the prepaid tuition plans offer higher returns. The drawback is that the accounts can only be used toward tuition in the state that offered the plan - or at the school that offered the plan. If you're certain you know your student will attend school in your state or even at a particular school, you could consider the prepaid tuition plans there. Otherwise, go with the savings type plan. You can invest in any state's plan - you don't have to choose your own state's plan. Be sure to shop around.

Qualified Educational Expenses

You can spend the money in a plan for tuition, housing (if the student is attending school at least half time), fees imposed by the school, books up to the cost budgeted by the school and for computer equipment used in education. No, that doesn't include an Xbox.

Beneficiary

When you open the account for your child, you'll have to designate your child as a beneficiary. There is no penalty for later deciding to give the money to another one of your children; you simply change the beneficiary. If the original beneficiary doesn't use all the money and you have no other children, you can change the beneficiary to be a niece or nephew or to the parents of your nieces and nephews (your siblings).

Non-education Distributions

If you distribute the excess funds other than for college expenses, all of the income on the distributed value will be subject to tax and a 10% penalty.

As you can see, there are some important benefits with 529 Plans but there are some hazards. The risks are small if you have a number of children planning to attend college. Be sure to compare plans in a variety of states before you start investing.