529 plans and ESAs are far from identical, and no single plan is best for everyone. As you decide how to invest your college funds, your first step is to know what distinguishes each of these special tax-advantaged plans.

529 PLANS
529 plans are programs sponsored by the states to give families a way to invest money for college that provides real tax advantages. While the 529 savings plans are the most common, the plans actually come in two flavors: savings plans and prepaid plans.

As you might expect, with college savings plans, you invest contributions with the goal of meeting college costs in the future, and with prepaid plans, you pay now for college later.

Most 529 savings plans are run by private financial services companies on behalf of the states that sponsor them. Your funds grow tax-deferred, and withdrawals for qualified education expenses are federal-tax free. Over half the states have made them state-tax free, too, but sometimes only if you’re part of that state’s plan.

529 plans are extremely flexible in terms of who can contribute and how much. Some 529 plans let you begin with a minimum contribution as low as $25 (or $15 if you enroll through an employer's payroll deduction plan), and you can sock away quite a bit. Some plans let you put away more than $270,000 over the life of the plan.

Usually, you're not limited to choosing the plan sponsored by the state where you live. However, you may want to start by investigating your state's plan, since there may be tax advantages. Each state's plan is different, so shop around. There are also very few restrictions on where your beneficiary attends college: Basically, it must be an accredited institution. But it doesn't have to be in the state sponsoring the plan.

www.collegesavings.org
Get information on all of the state plans at this website, from the National Association of State Treasurers.

EDUCATION SAVINGS ACCOUNTS
A Coverdell education savings account (ESA) lets you save for education costs for students from kindergarten to graduate school, and withdrawals for qualified education expenses are tax free. However, the maximum total contribution from all donors for a single beneficiary is $2,000 per year. And when it comes to college, ESAs can be used to cover fewer expenses than 529 plans.

ESAs do offer more investment flexibility, however. You can invest the contribution any way you like, and earnings accumulate tax deferred. You can also sell assets within the account that have increased in value and reinvest the money without incurring capital gains tax.

This is probably not the account for you if you’re the student, since the beneficiary must be younger than 18 when the account is established, and the money must be spent on qualified education expenses before the beneficiary turns 30.

www.irs.gov
Read the IRS explanation of the tax treatment of Coverdell ESAs.

OUTSIDE LINKS

www.collegesavings.org
The National Association of State Treasurers’ website includes their "Guide to Understanding 529 Plans."

www.irs.gov
The IRS website publishes a list of articles on tax information for students, including information on Coverdell ESAs, qualified tuition plans (like the states’ 529 plans), and other tax breaks for higher education.