Whether your child is leaving for college next week, next year or 15 years from now, it’s always a good time to consider your college savings strategy and tax advantages. One path to take is the 529 plan, named after section 529 of the Internal Revenue Code. When considering your investment options, it’s important to note that there are two types of 529 plans: prepaid and savings. Prepaid plans are currently only offered in 11 states and allow participants to purchase tuition credits to be used in the future. Savings plans are different in that a fixed amount is contributed monthly and growth is based on market performance. This flavor of the 529 plan consists mostly of mutual funds. Both plans are either administered by states or higher education institutions. With the savings plan, the administration and record-keeping is often delegated to a financial services company.

When the college bills start coming, all funds from your 529 plan will be distributed tax-free if they are going to be used to cover qualified expenses. These qualified expenses include tuition, fees, books, supplies and required equipment. The money can also be used for room and board as long as the beneficiary is at least a half-time student. If your child plans to live on-campus, these expenses can be 100% covered using 529 distributions. If your child wishes to live off-campus, your 529 plan distributions will cover the amount up to the amount allowed by the college for federal financial aid purposes. If your distributions are not used for these expenses, they will then be subject to income tax and a 10% early withdrawal penalty unless certain exceptions are satisfied.

Currently, 34 states allow you to deduct some or all of your contributions from your state income at tax time. Contribution limits are set at the state level so be sure to research your options before making a decision. The key factors to consider when deciding on a plan are the program expenses and investment options. For a complete list of state plans and their details, visit the Kiplinger website. They’ve complied a complete listing and even picked out a few favorites.

From a tax perspective, it’s important to note that you can’t double dip on tax benefits. This means the money you use to pay for college from a 529 plan can’t be used when calculating other education tax credits. That being said, the 529 plan still offers a great advantage. Even though you cannot deduct your contributions on your federal income tax return, the account’s growth will never be taxed if used appropriately.

If, at the end of all of your hard work and diligent savings, if your child decides they prefer traveling the world over going to college, not to worry. Any unused amounts can be transferred to other family members without penalty. For more details you can also reference Publication 970 on the IRS website.

Disclaimer: Every effort has been taken to provide the most accurate and honest analysis of the tax information provided in this blog. Please use your discretion before making any decisions based on the information provided. This blog is not intended to be a substitute for seeking professional tax advice based on your individual needs.