A 529 college savings plan is a state-sponsored investment that helps save money for college tuition and expenses. 529 plans offer a number of benefits, which vary by state, including tax-deferred growth and federal tax-free income withdrawals.

There are two types of 529 plans: college savings plans and pre-paid tuition plans.

In addition to the federal tax benefit, many states offer a state income tax deduction for contributions to their plans as well as state income tax-free withdrawals for qualified expenses. The federal income tax-free treatment of withdrawals and other federal tax benefits are now permanent for 529 plans through the passage of the Pension Protection Act of 2006. 529 plans also provide gift and estate tax planning benefits.

Each 529 college savings plan is sponsored by a particular state or group of states. While each plan is slightly different, they share many basic elements. Any earnings accumulated in a 529 savings account grows tax-free. Withdrawals from the account are tax-free when used to pay for qualified educational expenses, such as college tuition, room and board, and books at any accredited college, university, or vocational program in the United States and at a number of foreign institutions.

A distinct beneficiary must be named when establishing a 529 savings plan, but the beneficiary may be changed, as long as the new beneficiary is a member of the same extended family.

In most cases, an individual can sign up with any state's plan, even if neither they nor the beneficiary live in that state. There are restrictions limiting who can contribute to a plan. Total plan contribution limits top-out above $300,000 in some states, and a one-time contribution of $60,000 ($120,000 per married couple) can be made without incurring gift taxes, every five years. Grandparents or others who wish to contribute to a child's college savings plan may want to open a separate account.

Once an account is setup, the account owner manages all of the funds in a 529 college savings plan. Assets are usually invested in an investment portfolio, which is serviced by a specific financial company. Investment options often include stock mutual funds, bond mutual funds, and money market funds, as well as, age-based portfolios that automatically shift toward more conservative investments as the beneficiary gets closer to college age.

Participation in 529 savings plans has grown significantly. In 2000, $2.6 billion was invested in 529 plans. This amount grew to $14 billion in 2001 and more than $92 billion in 2006. It is projected that at least $175 billion will be invested by the year 2010.

All fifty states and the District of Columbia sponsor at least one type of 529 plan. A group of several hundred private colleges also offers a national prepaid tuition plan for private and independent colleges known as the Independent 529 Plan.

It is important to research your state's plan, as well as other independent plans to see which offers the best benefits and tax-advantages. Specifics of plans vary by state. In general, however, most 529 plans have the following attributes and stipulations.

Prepaid tuition plans typically charge enrollment and administrative fees. In addition to fees charged for broker-sold plans, college savings plans may charge enrollment fees, annual maintenance fees, and asset management fees. Some fees are collected by the state sponsoring the plan, and the financial services firm that the state hires to manage the plan collects other fees. Some college savings plans waive or reduce these fees if you maintain a large account balance or participate in an automatic contribution plan, or if you are a resident of the state sponsoring the 529 plan.

There is a lifetime maximum account balance of $300,000 or more, varying by state.

The treatment of investments in a 529 savings plan varies by school. However, investing in a 529 plan generally reduces a student's eligibility to participate in need-based financial aid. Beginning July 1, 2006, assets held in pre-paid tuition plans and college savings plans are treated similarly for federal financial aid purposes. Both are treated as parental assets in the calculation of the expected family contribution toward college costs.

Contributions are available for withdrawal 10 days after receipt of contribution. Withdrawals for purposes other than qualified educational expenses are subject to regular income tax and may incur a 10% penalty on the earnings in the account.

Qualified higher education expenses include tuition, mandatory school fees, books, supplies and equipment, and, under certain circumstances, room and board expenses. Eligible institutions are typically accredited post-secondary educational institutions offering credit toward a bachelor's degree, an associate's degree, or a graduate-level or professional degree.

While in the account, earnings are federal and state income tax deferred. Withdrawals used for qualified higher education expenses are also exempt from federal income tax, and possibly state income tax. This federal income tax-free treatment of qualified withdrawals and other federal tax benefits are now permanent for 529 plans through the passage of the Pension Protection Act of 2006.