A 529 plan provides a tax-advantaged way to save for your child's college education. All 50 states and the District of Columbia offer at least one type of 529 plan. There are no income restrictions on your ability to contribute to such a plan (named after Section 529 of the Internal Revenue Code), and there's no limit on the number of plans you can set up.

There are two main types of 529 plan: a savings plan and a prepaid plan.

Savings plan

With a 529 savings plan, you build a fund to help pay for qualified expenses at almost any private or public college or university in any state. You can also use a 529 savings plan to cover up to $10,000 of qualified K-12 tuition each year. Or you can withdraw a lifetime maximum of $10,000 to pay down qualified student loan debt. Most states sponsor a 529 savings plan.

Qualified expenses include:

• Tuition and fees
• Room and board
• Books and supplies
• Computers and related costs

The amount of each contribution you make to your account is up to you, although some states set a minimum on contributions, and each state has its own lifetime limit. You invest your account among a given set of options — typically mutual funds.

For federal income tax purposes, your contributions are neither pretax nor tax-deductible. However, under federal tax rules, any investment earnings on your account are tax-deferred — and they're tax-free when withdrawn to cover qualified expenses. Some states that have an income tax allow their residents to deduct or take a credit for 529 savings plan contributions on their state returns. Qualified distributions are generally state tax-free, too.

You can withdraw assets from your account at any time for a nonqualified reason. In this situation, your contributions will be tax-free upon withdrawal, but any earnings you withdraw will be subject to federal income tax plus typically a 10% federal penalty.

Prepaid plans

With a prepaid plan, you protect against inflation by locking in at least part of your child's future college tuition at today's level. Your contributions to the plan are used to prepay tuition at any covered public college or university located in the state that operates the plan.

Your contributions get credited with investment earnings based on average tuition increases. Any earnings that go toward paying for qualified tuition are exempt from federal income tax and may be exempt from state income tax, too. Although your contributions are not deductible for federal income tax purposes, some states allow residents to deduct or take a credit for contributions on state returns.

In most cases, funds in a prepaid plan account can be used to pay tuition at a college or university not covered by the plan. However, if tuition is higher at the non-covered school, the amount saved in the plan may not be enough to cover all tuition costs at that school.

If you make a nonqualified withdrawal from your prepaid plan account, any contributions you take out will be tax-free and penalty-free. However, any earnings you withdraw in nonqualified circumstances will be subject to ordinary income tax plus typically a 10% federal penalty.

What about the federal gift tax?

Contributions to a 529 plan are subject to favorable gift tax treatment that's unique to these plans.

Under the federal "unified gift and estate tax system," the gift tax applies to taxable gifts you make during your lifetime, and after your passing, the estate tax applies to taxable distributions from your estate. Typically, the annual gift tax exclusion allows you to give up to $15,000 per beneficiary, per year ($30,000 per beneficiary, per year if it's you and your spouse giving jointly) without triggering the gift tax. However, when it comes to 529 plan contributions, you can basically use up to five years of annual exclusions at once — for a tax-free gift of up to $75,000 per recipient ($150,000 if it's you and your spouse giving jointly).

This material is provided solely for educational purposes; it does not take into account any specific individual facts and circumstances. It is not intended, and should not be relied upon, as tax, accounting, or legal advice.