On the topic of various ways to save and pay for college tuition, the options that are most often discussed include applying for  federal or state loans, applying for scholarships, and private loans. There’s one method of saving that, for one reason or another, still remains relatively obscure: a 529 plan.

What is a 529 Plan?

Simply described, a 529 plan is a state-sponsored investment account specifically for a beneficiary’s education expenses. Some educational institutions also offer 529 plans. Named after Section 529 of the IRS tax code, a 529 plan, or Qualified Tuition Plan (QTP), allows family members and non-relatives alike to build accumulating savings for a child’s higher education expenses such as tuition and room and board.

The most considerable advantage of a 529 plan is that “earnings are not subject to federal tax and generally not subject to state tax when used for the qualified education expenses of the designated beneficiary, such as tuition, fees, books, as well as room and board,” according to IRS.gov. The ability for a 529 plan to thrive tax-free, the flexibility that allows anyone to contribute, and the diversity that allows you to open plans in multiple states are among the many strengths of a 529 plan.

Keep in mind that there are penalties that can occur when withdrawing from a 529 plan to use for indirect college costs such as transportation and repayment of student loans. If you end up deciding to use funds in your 529 plan for unrelated expenses, those funds are subject to taxes and penalties on the earnings of your contributions.

How does a 529 plan work?

There are two forms of 529 plans: 529 Savings Plans and 529 Prepaid Plans. 529 savings plans invest your contributions similarly to a 401(K) account. There are numerous investment options available, and you may start a savings plan directly or use a financial advisor with the expertise to identify the best plan for your family.

With a prepaid plan, tax-exempt pre-payments are made to be used in the future to pay for college expenses. These are often in the form of tuition credits. Prepaid 529 plans are sometimes more restrictive: prepaid plans generally cover just tuition and associated fees, while savings plans often cover supplies, room and board, and sometimes expenses like computers and internet access. State-sponsored prepaid plans can generally only be utilized by the sponsoring state’s residents. An alternative to a state-sponsored prepaid plan is the Private College 529 Plan, a program that allows for the purchase of tuition credits from 300 participating colleges.

Which 529 Plan is best for a beneficiary?

529 plans overall are impressively versatile, and some states in the U.S. offer varying tax incentives. There’s no particular 529 plan that is absolute for all families. Saving For College has an extensive list of plans searchable by state and type, as well as comparisons between the the tax advantages offered by different states.

Taking advantage of a 529 Plan/ Qualified Tuition Program

Despite the favorable merits of a qualified tuition program plan, relatively few families use them to pay for college. According to Sallie Mae’s 2017 “How America Pays for College” report, only 13% of families surveyed used a 529 plan in the 2016-17 year, down from 16% the previous year, while scholarships and borrowing were leading sources of payment (as well as income and savings, which does include 529 plans). Since there is such a high number of 529 plans available to review, a discussion with an experienced, dedicated financial advisor is likely to help your family identify the most preferable plan to accelerate saving for college expenses.