529 plans come in two forms: savings account and prepaid tuition. If you use prepaid tuition,you purchase units that can be turned into credit hours at a public college. Prepaid plans are appropriate for parents who don't like risk. With a savings account, you would invest money into a mutual fund. The account would fluctuate with market conditions---a good option for those who can stick with the investment markets.
Pick your state. You're not forced to open a 529 account in the state where you live. You may fund an account where you live or in another state miles away. However, you will be eligible for a tax deduction if you open a plan in your home state. Approximately 32 states, and the District of Columbia, allow deductions for 529 contributions. Pennsylvania, Arizona, Maine and Kansas allow you to claim a deduction even if you are not a resident.
You need to know the rules. Only 13 states operate prepaid tuition plans. Funds must be used at public institutions. However, independent 529 plans are available in select states if you're interested in private universities. Prepaid tuition plans protect you from future tuition increases. Savings accounts are generally more flexible. You are allowed to use the funds at a private or public university of your choice. Both plans are subject to strict penalties on unqualified withdrawals. Both plans are tax deferred, meaning you contributions are not subject to state and federal taxes. Nevertheless, you'll pay income taxes plus a 10 percent penalty if funds are used for non-educational expenses.
Look for the lowest fees. Check all the fees associated with opening and maintaining your account. Savings plans sold by brokers may be subject to a load fee---paid to broker for selling the plan. They also charge distribution fees that can amount to 1 percent of your initial investment. Direct sold savings plans allow you to avoid load fees.
There are other things to consider. Both accounts will reduce your student's financial aid package. Prepaid tuition and savings account are counted as parental assets and can only reduce need-based federal aid by 5.64 percent.