529 plans, named for Section 529 of the Internal Revenue Code, are investment plans with tax advantages, designed to entice families to maintain dedicated savings for higher education. Invested monies are exempt from federal taxes and, in some cases, state taxes. There are two types of 529 plans: the prepaid tuition plan and the more common and talked-about college savings plan. 529 plans are not run by the federal government. Rather, individual states sponsor these plans and determine how they will be structured. In the case of savings plans, states partner with financial management companies that handle the business end and deal directly with family investors. Many plans allow out-of-state investors but often there are additional incentives for investing in your state of residence.

Generally, 529 plans are more advantageous for families planning in considerable advance of college years - some plans allow parents to set up accounts for their children as early as infancy - but a strategic choice of plan can still yield returns for families close to the start of college enrollment.

• 529 Prepaid Tuition Plan: Prepaid tuition plans allow families to purchase shares of a public in-state education at current rates, regardless of how inflation affects rates by the time students enroll in school. Families can purchase units of tuition or contracts that cover a certain number of years of tuition. While prepaid tuition plans are low-risk investments, independent of market fluctuations and guaranteed by the states, they are typically restricted to in-state public schools and cover only basic tuition and fees. Additionally, there are time limits within which families can purchase tuition shares. The Independent 529 Plan is a prepaid tuition plan for a consortium of private schools. Plans are based on sample colleges and apply to member schools but families have options to rollover, refund, or rename beneficiaries if students decide to attend a school out of the consortium. For details, visit: http://www.independent529plan.org/index.html.
• 529 College Savings Plan: College savings plans are investment plans along the lines of an IRA. Investments are typically funneled into stock mutual funds, bond mutual funds, or money market funds, but all contributions are subject to market risk and fluctuations. To offset market variability, some 529 savings plans offer age-based portfolios that grow more conservative as students reach college-age or the option to invest money as a certificate of deposit.

  - Plans are custodial: parents contribute to accounts designated to the student beneficiary.

  - Plans are not guaranteed and many have contribution limits.

  - Plans can be used for expenses beyond tuition and fees, such as room and board, books and supplies, so long as they meet plan definition of qualifying expenses. Withdrawn 529 savings that exceed qualifying expenses are subject to taxes.

  - Plans have no enrollment limits or residency requirements.

For individual state college savings plans, consult CSPN, College Savings Plan Network: (http://www.collegesavings.org/index.aspx). For detailed information on college savings, visit http://www.savingforcollege.com.

Choosing a 529 College Savings Plan

Families are not restricted to plans provided by their states of residency and can browse the 529 marketplace for the best choice. While in-state plans may save families state taxes and offer other incentives, out-of-state plans may offer better performing portfolios and lower fees. Shop around and compare the finer details of structure and the various fees that are built into plans. Fees are deducted from your investment and over time can diminish a substantial amount from your return. Look for flat fees such as enrollment fees and annual maintenance fees, as well as administration fees and fund expenses that are calculated as percentages of your investment. Additionally, there are fees that vary depending on how you invest and how much you invest.

• Front-End Load Fees: Also called Sales Fees. 529 plans are either direct-sold or broker-sold. Direct-sold allow families to independently select and invest. Broker-sold require families to invest via a broker or advisor; broker sales fees vary depending on type and amount of investment. .
• Class Fees: 529 plans structured like mutual funds offer different classes of shares: Class A, Class B, and Class C. Fees vary depending on class. Examine front-end loads, back-end loads, and breakpoint discounts.

Coverdell Education Savings Accounts

Coverdell Education Savings Accounts (ESAs) are similar to 529 College Savings Plans. Families contribute to an investment account dedicated to education and are spared the federal income taxes as that investment grows and when it is withdrawn for qualifying education expenses, including tuition, fees, room and board, books and supplies. Unlike 529 College Savings Plans, families can pretty much choose how and where they invest their money. Families can currently contribute a maximum of $2,000 per year until the beneficiary reaches the age of 18. Taxes are applied to savings that exceed qualifying expenses or savings that fail to be withdrawn in full by the time the beneficiary turns thirty. Note, come the end of 2010, families will only be able to contribute a maximum of $500 per year.

College Savings Plans & Financial Aid

Both 529 plans and ESAs are considered parental assets in federal financial aid methodology, calculated at 5.6% of account value, as opposed to 20% if the assets were considered student owned. Withdrawals are not only excluded from federal taxes but they do not need to be reported on federal aid applications.

Sources:

• "529 Plans" (http://apps.finra.org/investor_information/smart/529/305000.asp), "College Savings Plans" FINRA, (http://apps.finra.org/investor_information/smart/529/304000.asp)
• College Savings Plans Network (http://www.collegesavings.org/index.aspx)
• "Independent 529 Plan (http://www.independent529plan.org/index.html)
• "Understanding Mutual Fund Share Classes", 360 Degrees of Financial Literacy (http://www.360financialliteracy.org/Life+Stages/Retirement/Articles/Investments/Understanding+mutual+fund+share+classes.htm)
• "Coverdell Education Savings Accounts", IRS.gov (http://www.irs.gov/newsroom/article/0,,id=107636,00.html)
• The College Solution, Lynn O'Shaughnessy, FT Press, 2008