The lack of awareness is unfortunate because the plans are chock full of tax benefits. Investment earnings in a 529 plan are not subject to federal capital gains tax and generally not taxed by state governments when used for the qualified education expenses, such as tuition, fees, books, as well as room and board, of the designated beneficiary.
Thirty-three states and the District of Columbia sweeten the deal by giving residents a tax break if they invest in their state's 529 plan. Five states — Arizona, Kansas, Missouri, Montana and Pennsylvania — offer a state income tax deduction to residents for any 529 plan contributions.
"Looking at your state's plan is a good starting point," said Brett Tushingham, a certified financial planner at Tushingham Wealth Strategies, who specializes in college planning. "But don't let the tail wag the dog, so to speak."
Savingforcollege.com, a website that rates 529 plans, has a calculator to determine how much a plan's state tax deduction or credit is worth to you.
State tax breaks also can change. For example, North Carolina ended its state tax deduction for 529 contributions in 2014. And if you live in a state that doesn't have a state income tax, the plan's costs and investment options are more important considerations.
Beyond the tax benefits, investors should know about the two types of 529 college savings plans: those sold directly by the states and those sold through financial advisors. (To make matters more confusing, there are also 529 prepaid plans that allow account holders to buy tomorrow's tuition at today's prices at in-state public colleges and certain private schools.)
Direct-sold 529 plans generally have lower investment fees than advisor-sold ones. (See table below.) However, advisor-sold plans tend to offer more investment options than direct-sold plans.