If you invest in a child's savings account like a 529 College Savings plan, 529 Qualified Tuition plan or an Education Savings Account, the account can earn interest not subject to federal taxes.

Investing in one of these college savings plan in the name of your child also offers more than relief from the capital gains tax on a federal tax basis. In most states, there are also tax benefits for a 529 Savings Account such as those specified above. However, some states may limit just how much a particular investment will receive in terms of a tax break. If withdrawals are made from a college savings account or a prepaid tuition plan and withdrawals are not spent on qualified expenditures, these withdrawals may be penalized and taxed through the IRS. In some cases, these penalties do not apply, however, such as if the intended student receives a scholarship, acquires a disability, or dies.

If you're looking for just such a college savings account, you don't just have to consider only the 529 Qualified Tuition plan or prepaid tuition plans. You can also opt for the Coverdell Education Savings Account, which will not only cover higher education costs, but will also help out with eligible elementary and secondary school expenses. As with the 529 Prepaid Tuition Plan and the 529 College Savings Account, the Coverdell Education Savings Account will penalize you if you make purchases that do not qualify as a legitimate expense under the plan's specifications.

Just about anyone is eligible for either the 529 Prepaid Tuition Plan or the 529 College Savings Plans in most states. However, many states have the restriction that either the student or contributor must live in the state the plan or account was established in.

There is a disadvantage to using a 529 Plan or Education Savings Account. That is, there are usually limit caps of three hundred thousand dollars total for a 529 Plan or $2000 annually for a Coverdell ESA. Some plans may also limit how much can be invested annually and still qualify for a tax exemption. Regardless which route you choose, contributing to a 529 Savings Account is a prudent investment in your childrens future.