We've heard that investing in a 529 college-savings plan might affect our kids' financial-aid eligibility. Is this true?

Predicting just how withdrawals from a tax-free 529 college-savings plan will be handled by financial-aid offices more than a decade from now is tricky business. That said, it's a pretty safe assumption that, yes, they'll reduce financial-aid eligibility. But that doesn't mean you shouldn't continue with your contributions.

For what it's worth, right now 529 savings plans generally have relatively little impact on financial aid, says Ellen Frishberg, financial-aid officer at Johns Hopkins University. That's because under the federal formula (which is the formula used by most schools to determine financial need), they're currently considered part of the account owners' assets (typically the parents'), which are heavily protected in the need-analysis formulas. Under this methodology, no more than 5.6% of parental assets are deemed available for college costs. (Keep in mind, some private universities may assess 529 plans differently. Likewise, the rules are different for prepaid-tuition plans.)

Moreover, depending on the parents' ages, some assets are exempt from the financial-aid calculations. For example, if you're 45 years old, the first $42,100 of your assets are protected "before we even touch a dollar," says Frishberg. Those protection levels go higher as parents get older. So, to give a rough example, if you were 45 and had $100,000 in a 529 plan and no other investments when your child started college, your first year's financial-aid package would be reduced by just $3,242.40 (or 5.6% of $57,900). And this number would be even smaller for families that have another child already in college, Frishberg explains. To get an estimate of how much financial aid you'll qualify for, run your numbers in our calculator.

Note, though, that these are the current rules. They could change as early as this year, should Congress finally get around to clarifying how 529 accounts should be assessed. When that time comes, it's possible that Congress could decide that 529 plans should be considered assets of the beneficiary . Should that happen, up to 35% of the balance could be considered available for tuition each year.

But college-planning experts say that's not likely to happen. "The indication from the Department of Education is that it wants to continue to treat these savings accounts favorably," says Joseph Hurley, author of "The Best Way to Save for College: A Complete Guide to 529 Plans," and publisher of Savingforcollege.com, a Web resource on 529 plans. "Congress wants to encourage the use of these accounts by families."

As troubling as the uncertainty may be, it's important to keep your eye on the prize here. Financial-aid eligibility should not be your primary concern when determining how much to save. After all, these days the vast majority of aid takes the form of loans. So not saving now most likely ensures that your kids will be saddled with student loans come graduation.

Nevertheless, you should try to be strategic when saving for college. One thing to avoid is overfunding your 529 plan, says Rick Darvis, a CPA and certified college-planning specialist with College Funding in Montana. Sure, excess funds can be transferred among family members, including cousins and grandkids. They also can be used for graduate-school expenses. But withdrawals used for nonqualified expenses are taxed as ordinary income and hit with a 10% penalty. (The taxes and penalty are applied to the earnings, not the original contributions.) So the ideal situation for most is to have no money left over once the kids graduate.

Darvis recommends saving no more than the cost of four years at an in-state public college into a 529 plan. "If you invest more than that, thinking your kids are going to go to private school, and they don't, you get a bunch of excess money in that 529 plan," he says. If the goal is to save enough to pay for Harvard, Darvis suggests putting some money in tax-efficient mutual funds, so when the time comes to make withdrawals, the money will be taxed at the maximum 15% long-term capital-gains rate. That way, if it turns out the cash isn't needed for education, the parents can use it for something else.

Finally, let's talk scholarships. The good news is that if your child earns a scholarship to cover part or all of the tuition costs, the 529 plan will typically waive the 10% penalty on the money not needed to pay college costs. Yes, you'll still owe income taxes, but a smart way around it is making the distribution payable to the beneficiary, so you'll pay the beneficiary's tax rate, which is probably much lower than yours, says Hurley. That said, you shouldn't build your child's future around scholarship hopes. "Even if your kid's the new Einstein, getting a full-academic free ride is very rare," says Darvis.