Types of Section 529 Plans

• Section 529 Plans come in two main varieties--prepaid tuition and savings plans. Prepaid tuition plans let you lock in the cost of a given college's tuition at today's prices, helping to insulate yourself from the effects of inflation. Savings plans allow you to invest your savings in mutual funds, in the hope that the investment growth from the mutual fund will be enough to offset any increases in college costs.
  
  

Taxation of 529 Plans

• The Internal Revenue Service lays out the taxation of 529 plans, or Qualified Tuition Programs, in Publication 970, Tax Benefits to Education. Contributions to Section 529 plans are tax-deductible in the current year, and the money grows tax-free as long as it is left in the Section 529 plan. Withdrawals for qualified educational expenses, including tuition, fees, books, supplies, room, board and reasonable computer costs, are tax-free. Withdrawals for non-education-related purposes are generally taxed as ordinary income. The IRS additionally adds a 10 percent penalty to non-education-related withdrawals.
  
  

Eligibility

• Any taxpayer can contribute money to a Section 529 plan for any child, using any state's Section 529 plan. There are no upper income limits on Section 529 eligibility, and annual contribution caps in some plans are more than $200,000. However, contributions cannot be greater than those necessary to provide for a beneficiary's qualified educational expenses.
  
  

Plan Availability

• You do not need to contribute to your state's plan, though there may be state tax incentives to do so. Any parent, grandparent or other relative living in any state can contribute to any state's Section 529 Plan on behalf of a beneficiary in any other state.
  
  

Effects on Estate Planning

• Because of the high contribution limits to Section 529 plans, many affluent families have used Section 529 transfers as a way to get money out of a taxable estate. There is no estate tax as of 2010, but on January 1, 2011, estates over $1 million may be subject to estate taxes of up to 55 percent. Strategic gifting to a Section 529 plan could save some estates hundreds of thousands of dollars.