Even better, some states will also exempt your earnings from state income tax and let you deduct your annual contributions from your state tax return. You can withdraw the money early, although, as with an IRA, you'll pay a 10 percent penalty and income tax on any gains. That's why the plans work especially well for grandparents. If unexpected medical bills or some other emergency comes up before the child goes to school, they can access the money. Nothing's perfect, however, and there are some drawbacks.
Fees can also be a problem.
High-cost plans such as Colorado's, for instance, carry a 0.30 percent management fee from the state and an extra 0.99 percent charge from the plan administrator, Salomon Smith Barney. That doesn't include the mutual fund expense ratios, which run as high as 1.33 percent. Depending on your family, that might be a problem. If you have more than one child, you can just use the money for Junior's brother or sister. Further, once you start to make withdrawals, the money becomes part of your child's income.