Last week I answered a question about the Coverdell Education Savings Account. (Click HERE to read). But for some of you, the State 529 Plans may be a better deal.

Answer:

Here are the facts...

There are two types of state 529 plans: the College Savings Plan and the Prepaid Plan.

The College Savings Plan

In the State 529 College Savings Plan, your money is invested in a special account, containing stocks, bonds and money market funds or a combination of all three. Although the individual states administer the plans, the investment part is usually outsourced to an investment firm or mutual fund company. Plans differ from state to state but they have much in common:

• Earnings are exempt from federal taxes as are withdrawals as long as they go toward paying qualified college costs.
  
  
• Deposits can be made monthly or in a lump sum. Some plans require as little as $25 to open an account with subsequent investments of just $50.
  
  
• Plans have generous maximum contribution limits. In some states you can contribute up to $250,000 per beneficiary, at once or over the life of the investment.
  
  
• There is no age limit of the person you want to put through college - it could be you!
  
  
• The money can be used at any college, not just those in your state and when it is withdrawn to cover college costs, it is not taxed.
  
  
• You maintain control of the account. Although the money is for your child, he or she cannot withdraw the money and buy a BMW or take a trip around the world.
  
  
• Funds are treated as parental assets. Current financial aid formulas only count between 5% and 6% of parental assets when calculating a family's need figure.
  
  
• Grandparents can contribute. 529 contributions are considered "completed gifts and are excluded from one's estate. Grandparents can also switch beneficiaries to other grandchildren.
  
  
• Beneficiaries can also be switched to first cousins.
  
  
• You can contribute to a Coverdell Education Savings Account (explained last week) and 529 plans in the same year.

Caution: You are at market risk -- if the funds you select go down in value, so will your account. And, in most plans you can change investment options only once a year.

$TIP: You are not limited to joining your state's plan, but it might be very wise to do so. In over 20 state plans, part or all of your contributions are deductible from your state income tax.

The Prepaid Tuition Plan

In the State 529 Prepaid Tuition Plan (also called Prepaid Education Arrangements or PEAs) you lock in today's tuition price being charged at a public college or university within the state that is part of the plan.

There are two types of prepaid tuition plans. The units plan enables you to buy units of tuition. A unit might equal 1% of state college tuition or a set number of credit hours. A contract plan enables you to purchase one to five years of tuition.

• You can generally contribute to either of the two PEAs in a lump sum or in installments.
  
  
• Earnings are guaranteed by the state government to at least match in-state tuition increases.
  
  
• Most programs allow funds to be transferred to private or out-of-state schools, but then you must pay the difference between the prepaid tuition price and the current price of the out-of-state or private school.

There are some downsides to prepaid tuition plans:

• They do not cover room and board, only tuition.
  
  
• Most, but not all, permit parents to transfer the money to an out-of- state school in case their child wants to attend a college further away from home.
  
  
• Participation is often restricted to state residents or alumni of state colleges and universities.
  
  
• Your principal plus earnings may not cover tuition and account fees if your student goes out of state or to a private school.
  
  
• Pulling out of a plan usually results in stiff penalties and/or loss of interest.
  
  
• The plan can significantly reduce your family's eligibility for financial aid. Distributions paid to the college are treated like scholarships and thus reduces the family's need figure on a dollar-for-dollar basis.

Which 529 Plan Is Right For You?

The College Savings Plan generally offers more flexibility in selecting a college. And, if you qualify for need-based aid, the federal formula will ask you to contribute less from the College Savings Plan than from a Prepaid Tuition Plan. However, your College Savings Plan is at market risk.

$TIP: To find out about your state's 529 Plans, contact the National Association of State Treasurers (877-277-6496 or www.collegesavings.org). The website will link you to individual state plan administrators.