529 plans great choice for college savings, but pick carefully

Want to save for college, but not sure what type of account to use? State-sponsored 529 plans should definitely be your first choice. You don't have to pick one from your own state, but tax incentives might encourage you to do so. If your state doesn't off good tax incentives for colleges savings, then look for the plan with the lowest fees. Kiplinger's gives you an excellent overview of your options, as well as a state by state run down.

These state-sponsored plans can give you shelter from both federal and state income taxes, as well as give your child's grandparents a good way to chip in for their grandchild's education. In fact a grandparent can contribute up to $12,000 a year without having to worry about federal gift taxes (a couple can contribute up to $24,000 without gift taxes). If one grandchild decides not to go to college, just switch the account into the name of another child that wants to go. The money in the fund grows tax-deferred and as long as you only use it for qualified educational expenses you don't ever have to pay taxes on the gains.

You also don't have to worry about saving too much. The federal financial-aid formula assesses parent-owned accounts at 5.6%, while student savings can be assessed a whopping 20%. But, if you want to avoid taxes you must use the funds for qualified education expenses, so you don't want to save more than you think your child will need for college.