And take advantage of federal and state income tax benefits.

Like some of our friends and relatives, my husband and I used a 529 plan to save for our kids’ college education. The money we invested through the plan grew tax-free and allowed us to take advantage of a special state income tax credit, as well.

With a recent survey by the financial services firm Edward Jones revealing that two-thirds of Americans don’t know what a 529 college savings plan is, it seems time for a primer on this important program.

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The basics Created in 1996 under Section 529 of the Internal Revenue Code, the program helps families save for education, either by putting money aside in a prepaid tuition plan (see below) or in an investment account. Almost all states offer a 529 Plan. Though you don’t have to open an account in your own state, it tends to offer the best tax benefit.

Anyone can set up an account naming your student as the beneficiary—a parent, relative or family friend who wants to help with education expenses. Consult with a tax advisor to clarify any gift tax implications for those relatives and friends.

Your contribution (which can be made regularly through automatic withdrawals or randomly), is invested at a level of risk tied to a child’s age. The closer your student gets to college, the more conservative the investment strategy becomes. Capital gains are not taxed and money can be withdrawn tax-free as long as it’s used exclusively for educational expenses (see below).

In some states, contributions earn an income tax credit equal to the amount deposited. In New York State, that can be as high as $10,000 per year. This credit is given during the contribution year, not the withdrawal year. Each state has its own maximum contribution limit for a 529 account.

Non-qualified withdrawals (those unrelated to education) are subject to federal and state income tax plus a 10 percent penalty tax, similar to taking money out early from an IRA account or 401(k) plan.

Why you should sign-up Putting money, any amount, into a 529 Plan, means there is some money you are designating specifically for your child’s college education and it has potential to grow tax-free. Even if your teen is getting ready to head off to college in the fall, putting even a small amount of money aside now will help, making you eligible for those state income tax credits which can provide more money for college next year.

College-related expenses Funds from a 529 Plan can be used to pay for tuition, fees, room and board, books, supplies and equipment such as a computer (purchased while your student is in college and used for schoolwork). These costs can be for a public or private college, in or out of state.

FAFSA and a 529 Some parents worry about whether the money in a 529 Plan will affect their child’s eligibility for federal tuition assistance. It will be included as part of the parent’s untaxed income, but not the student’s, impacting your EFC less.

The lesser-known prepaid plans Everyone I know who’s participated in a 529 program chose the savings plan. But some states offer a prepaid tuition option. Essentially, your contributions will be used to purchase units or certificates for tuition at an in-state public college at the same price as when you opened the account, no matter when your child starts college or how high the cost of attendance rises.

State-run 529 plans work for in-state public colleges. The Private College 529 Plan is designed for private colleges, with 300 currently participating in the program.

Making the most of your credit card Check out 529 Plan linked credit cards, like Upromise, where a percentage of the amount of your purchases each month is deposited into your 529 account. The reward can be one to five percent, depending on the card and type of purchase. The math only makes sense if you pay your credit card in full every month, though.

You can also sign up for Upromise and use your current credit card(s) to earn cash back into your 529 account. Though it will be less than if you used a Upromise card, the savings on gas and grocery store purchases still add up.

Sharing the wealth What if you’ve put money aside for your student in a 529 account but they receive a substantial scholarship and don’t need all the money? You can roll it into a 529 account for another of your children, or keep the account open in case that first kid eventually plans to attend grad school.

Share your experiences saving through a 529 Plan in the comments section below.

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