As tuition costs climb, saving early for education is one of the most important decisions parents can make. Tax-advantaged 529 savings plans, offered by states for almost two decades, are now one of the most popular options for making sure school expenses are covered when your child reaches college age. 

A 529 plan is a college savings account that’s exempt from federal taxes. The plans were introduced in 1996 to help taxpayers save for college expenses for a designated beneficiary.

These plans, named for Section 529 of the federal tax code, often have tax benefits at the state level for in-state residents. This only applies to states that have an income tax. 

Any U.S. citizen or resident alien at least 18 years or older can open a 529 account. Usually, the beneficiary is a child, grandchild or younger relative. However, an adult can also open a 529 plan to save for his or her own higher education costs; there are no age limits.

There are two types of 529 plans: prepaid tuition plans and college savings investment plans. Those who open a prepaid tuition plan lock in the current costs of tuition in place of future prices, which generally rise every year.

College savings plans have grown in popularity during the past few years, while several prepaid tuition plans have stopped accepting new enrollees or shut down entirely. Some particular drawbacks are that the money put into a state-run prepaid plan may only be applied to tuition and fees at in-state public colleges and universities. Room, board, books, and other expenses aren’t included and must be covered separately.

For college savings plans, eligible institutions include most accredited colleges and graduate schools, including professional and trade schools. Contributions apply to a variety of qualified educational expenses, including tuition, books, and room and board for those attending at least half time.

Approved transactions are often referred to as qualified withdrawals and vary slightly from plan to plan. If contributions go toward unauthorized purchases, the tax deductions are recaptured, and there may be additional monetary penalties.

Within each state, there are often multiple plans from which to choose, and dozens of state plans are sold nationally, regardless of where the account owner lives. Don’t limit yourself to only your state’s offerings, particularly if you live in a state with no income tax. Each plan comes with a host of corresponding fees (see below), including maintenance and investment fees.

In most cases, the money you contribute is invested in large, widely held mutual funds managed by well-established financial companies. Each plan option includes a different mix of mutual funds, and you can pick your plan with one of two approaches. 

The first, an age-based option, automatically adjusts your asset mix to become less risky as your student approaches college age. That means you’ll start with a higher allocation to stocks, which gradually tilts toward cash and bonds over time. This automatic adjustment makes age-based tracks more popular among people who do not want the responsibility of personally managing the allocations in their 529 portfolio.

The second option is called the static choice. Here, you hold an investment fund or group of funds that maintains the same allocations over time.

Every 529 plan carries various fees. These can be complicated to sort through, but essentially they break down into advisor fees, program management and maintenance charges, and underlying investment fees. Remember that an in-state tax deduction, if available, can offset a number of plan fees. Fees can vary significantly between plans, and actively managed funds generally carry higher underlying expenses than index funds. States and program managers also waive fees for various reasons, including if you fund your account via direct deposit. When choosing a plan, be sure to look into any fee waivers that may apply.

The following are some of the fees you may incur: 

While each state enforces its own set of 529 regulations, the federal government enforces certain policies on all 529 plans whether they are national, state, direct-sold, or adviser-sold.

Only one person can own a 529 account, and there can only be one beneficiary to that account. One person can own multiple 529 accounts, however, and a beneficiary can receive contributions from multiple accounts as long as the collective amount of money in all the accounts does not exceed the state maximum limit on contributions.

In addition, people other than the account owner can contribute to the plan. The account owner can also change the beneficiary to one of the beneficiary’s relatives, and in case of the account owner’s death, a new account owner can be named without tax penalties.

Sometimes people wonder about the federal gift tax exclusion and how it applies to a 529 plan. The short answer is that, you pay no gift taxes for 529 contributions. However, there are some guidelines about reporting gifts to the IRS, regardless of your estate size or planned lifetime giving. As of 2014, the gift tax exclusion amount is $14,000 per beneficiary or $70,000 per beneficiary as one lump sum, once every five years. It’s best to consult a certified public accountant with specific questions about your situation.

Though 529 policies vary from state to state, for the most part they follow the same basic guidelines. When surveying 529 plans, however, compare tax deductions, fees, and expenses to find out if your state plans are fairly priced. State tax deductions are the best incentive for residents to use one of their state’s 529 plans.

Most contribution limits are between $300,000 and $400,000 per beneficiary. In addition, most 529 savings plans do not require you to withdraw your contributions within a certain period of time or have a significant age requirement. That’s a key difference between savings plans and prepaid tuition plans; the latter often have time limits for withdrawals. In addition, you won’t pay state or federal taxes when the 529 money is withdrawn and used for qualified, college-related expenses.

If you would like to switch your account to another plan, every state allows you a once-per-year rollover to another 529 plan with no tax consequences. However, many states charge you for transferring your account or recapture your state tax deductions if you move from an in-state plan to an out-of-state plan.

Several states have scholarship or grant programs in conjunction with their 529 plans.

Generally speaking, these programs fall into two categories. First, many states offer a gift to newborn state residents. Maine, North Dakota, and Rhode Island provide a small amount of seed money for 529 accounts that are opened before a child’s first birthday. 

The second type of grant program is a matching grant to help low- and middle-income families afford college. In most cases, the account owner or beneficiary must be a state resident, and there are sometimes additional restrictions on how the money may be used.