My brother brought my attention to 529s about a year ago, when my baby was born. The past year was filled with taking care of this newborn, so it wasn't until last week that I got to spend a few days researching 529s. 529 is a tax deferred investment account solely for the purpose of paying for education expenses. It is imperative that all the benefits and restrictions be listed so that an informed decision can be reached regarding whether or not such an account should be opened.

In the ideal situation, a 529 account is opened when the baby is born. Deposits and stock market growth increases the balance for 18 years, at which point the beneficiary uses it to pay for higher education. The cost of tuition is paid for by the money in this account, with nothing left over.

But what happens if the situation is less than ideal? If the money is withdrawn and used for anything other than education expenses, the earnings (profit not including the principal) is taxed as income plus an additional 10% penalty. An exception is if the beneficiary receives a scholarship.

In order to use the money without taxes or penalties, in the event that the beneficiary does not need the money, a different beneficiary can be selected who needs money for higher education. Thus, as the future cannot be easily predicted, it is probably a good idea to not overly fund the account, as the funds are limited to being used for education expenses.

If the 529 account belongs to a parent of the beneficiary, it will impact the amount of financial aid that the beneficiary will qualify for. Interestingly, if the 529 account belongs to a grandparent, financial aid eligibility is not affected.

529 accounts are investment accounts with a variety of options ranging from individual stock picks to index funds. The expense ratio is something that needs to be carefully scrutinized when selecting investment types.

529 are run by states, that pass the operation down to underlying investment banks. Specifically, many 529 invest in Vanguard Funds or Fidelity Investments. Even though 529s are run by states, nonresidents are able to freely open 529 accounts belonging to any state.