Given these trends, parents are saving for college early; nowadays many families open a college savings account in the first years of their child’s life. Offering significant tax advantages and a lot of flexibility, 529 plans are a popular option to save for a college education.

Parents can choose from two types of 529 plans: prepaid programs that allow you to purchase tuition credits at current rates for future use, and savings plans where contributions are invested for future use.

Although contributions to these plans aren’t deductable for federal tax purposes, withdrawals are exempt and 32 states allow taxpayers to deduct contributions to qualified 529 plans for state income taxes. The table “Untaxing Endeavor” lists the 12 states that offer deductions of at least $5,000 on contributions to qualified plans. Keep in mind that unless you’re a resident of Arizona, Kansas, Maine or Pennsylvania, which allow contributions to plans from any state to be deducted, only contributions to plans in your state are deductable.

Some states offer carry-forward periods in which contributions over the deductible amount may be claimed in future tax years. Scholarship programs and matching grants are also available in 14 states. A listing of states offering these incentives can be found here.

And it’s easy to designate a different beneficiary for a 529 plan in case your future student has different ambitions.

Money from the plans can also be used to cover a wide range of expenses aside from tuition–fees, books, supplies and room and board can be paid out of the accounts. In some cases, a percentage of off-campus housing expenses can also be covered through the 529 plan. With no income thresholds to limit eligibility, 529 plans are available to everyone. And if your child receives a scholarship, any unused money can be withdrawn without penalty–less taxes owed.

How to Choose

With literally hundreds of 529 plans available and relatively few restrictions on who can invest where, expenses are a key consideration. Some plans charge relatively few fees; others collect enrollment, transfer and annual management fees–that’s on top of the fees charged by the funds in which you invest. And some plans even carry loaded funds on which you’ll have to pay up-front sales charges.

Always look for plans that charge as few fees as possible and offer a wide variety of investment choices. Many plans only offer a handful of age-based options or fixed-risk portfolios, while others offer a variety of single fund options for those looking to build their own portfolios.

Choose carefully. Once you’ve set up a plan and allocated your assets, you’re locked in with both your fund selections and the plan for at least a full calendar year.

Two excellent yardsticks are Ohio’s CollegeAdvantage and Virginia 529 College Savings Plan. Both offer a diversity of investment options and reasonable fees. Illinois’ Bright Start plan also ranks well for fees, though some of the investment options are questionable.

An excellent starting point for your research is http://www.savingforcollege.com, a website that allows you to compare different plans and offers a wealth of information on financial aid planning.

Other Considerations

The value of these savings plans are taken into account when determining financial aid eligibility. If the 529 is in the name of either the parent or the student, 5.64 percent of the plan’s value is factored into the financial aid calculation. If someone other than the student or parent owns the account, it may not enter into the equation. We recommend that readers consult a financial advisor before attempting this workaround.

And any earnings on the plan that are withdrawn for purposes other than eligible educational expenses are subject to income tax and an additional 10 percent federal tax penalty. In this instance, some states will also recapture any state income tax deductions taken.

When the current rules governing 529 plans expire in 2011, distributions could count as income for the student. But given the popularity of these plans and the Obama administration’s emphasis on education, many expect Congress to extend the current rules.

As always, talk with your financial and tax advisors before deciding which plans are right for you. But be careful when you speak with an advisor; many brokers and advisors collect commissions on their recommendations, so always check to make sure you’re getting the best deal possible.