Families saving for higher education can take advantage of the newest tax-preferred investment plans, 529 college savings plans. These plans, named after the section of the tax code that approves them, allow qualified withdrawals to be made tax-free – and contribution limits are significantly higher than for education IRAs (now known as Coverdell Education Savings Accounts). 

The real advantage to a 529 plan is the tax-deferred interest compounding, similar to an IRA. The earlier the plan is set up, the greater the benefit of tax-sheltered compounding. Typically, money from a 529 college savings plan can be used at any school you choose and for any qualified education expense, including room and board. 

Depending upon the state plan, there may be multiple ways to set up a college savings plan: directly from the sponsoring state or mutual fund company that administers the plan, from a broker/dealer, or a financial advisor. Some states allow you to choose identical plans either through a broker or directly from the state. The difference? Expenses are likely to be higher when working with a broker because of the load or commission paid to the broker. When buying directly from the state, all of your investment goes to work for you immediately. 

While you can still use the federal tax deduction when you purchase a plan sponsored by a state other than where you live, you may lose your home state tax deduction. 

As with all major financial decisions, it pays to do your homework before deciding if a 529 college savings plan makes sense for your family.