College Savings Improvements

Saving for college just got a little bit easier, sort of. In the same fell swoop with which Congress recently lopped billions of dollars off federal college-loan programs it also made some improvements to the tax-exempt funds known as 529 plans.

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The 529 plans are state-run investment programs that allow you to contribute toward a college education while reaping tax and other benefits. Contributions to 529s are made with after-tax dollars but the income generated from the invested money is tax-exempt and can be used for tuition, room and board and even books at any accredited college in the U.S.

There are plenty of other benefits to the plans as well, including favorable terms under the gift tax, high maximum contributions, rollover flexibility and impact on financial aid.

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Every state runs at least one plan and many run more than one. You don't have to be a resident of a state to invest in its 529 plan.

That's a good thing, because some plans have come in for considerable criticism in the past few years over high fees, which can significantly cut into the returns on your savings. A crowded field of more than 80 plans, not including prepaid-tuition plans, has also created confusion with consumers.

However, 529s just got a boost from Congress and remain among the most popular ways to save for college. In the past year, assets invested in 529's nationwide grew 30% to $68.4 billion.

The new law makes it easier to transfer a child's existing assets into a 529 and grants the same financial-aid benefits to prepaid plans as to the savings plans. And the bad publicity about excessive fees is driving offenders out of business and raising awareness about choosing a plan that's appropriate.

"If you can invest for college without paying income tax on your earnings, you're going to have more money for college," reasons Joseph Hurley, founder and CEO of and a certified public accountant.

So how do you go about selecting a 529?

Start with your home state's plan. Many states offer income-tax exemptions to in-state buyers. Others match funds for low-income families or offer protection from creditors.

If you have to go out of state, consider talking to a broker or financial adviser. You'll pay an extra fee but the array of 529s out there can be daunting without a guide.

Morningstar's Kerry O'Boyle advises would-be investors to choose funds run by low-cost managers such as Vanguard or T. Rowe Price and to look for portfolios that diversify appropriately.

Some plans automatically shift your money from aggressive portfolios to increasingly conservative ones as the beneficiary nears college age.

Copyright (c) 2006 MarketWatch, Inc.