Getting Educated About 529 Savings Plans

Here are three reasons why I think the plans are great and three reasons why you should look before you leap.

The Good

The tax benefits are fabulous. You can contribute up to $300,000 in after-tax dollars to most 529 accounts. Then, as long as the beneficiary uses the proceeds for college expenses, withdrawals are completely tax-free. So that means you won't owe tax on the earnings. That alone makes these plans worthy of consideration.

If you're really looking to jump-start Junior's account, you can contribute up to $12,000 per year (or $24,000 as a married couple) without incurring a tax on the gift. And for anyone who needs to get money out of her estate (hello, Grandma!), she could make a lump-sum contribution of $60,000 ($120,000 for a married couple) without any adverse gift or estate-tax consequences, provided she doesn't make any additional contributions to that account for the next five years.

Even better, at this point, 26 states and the District of Columbia offer state tax benefits as well. For instance, if you're a New York resident and invest in the state's 529 savings plan, currently run by Vanguard, you could get a state income tax deduction of up to $5,000 ($10,000 for married couples filing jointly).

Other states offer different incentives. While New Jersey doesn't offer a state tax deduction, it will kick in a $1,500 scholarship if you open the state's 529 plan and your kid ends up at a Jersey school. Hey, it's something.

These 529 plans don't affect your child's eligibility for financial aid. That's because the account is not in the child's name. The child is merely the beneficiary. And when schools calculate financial aid, they place the most emphasis on the assets in your kid's name. That's why a custodial account such as an UTMA -- Uniform Transfer to Minors Act account -- can hurt your kid's financial aid chances. Theoretically, that account is in his name and is his for the taking when he reaches the age of majority in your state. So for financial aid purposes, the lower amount of assets in your kid's name, the better.

For someone like me -- and I'm sure many people out there -- this is very important point, because even with all my savings attempts, I'll still probably come up short and need some additional financial help.

These 529 plans have a ton of investment options these days. Whether you want to invest aggressively or throw it all in conservative CD options, there's a plan out there that will fit your needs.

And many offer my favorite, age-based portfolios where the equity and fixed-income ratios are automatically adjusted each year as your kid gets closer to college. So for instance, if you opened an age-based account for your newborn in Fidelity's UNIQUE 529 plan, sponsored by the state of New Hampshire, about 87% would be in equity funds at the time of his birth. By the time that kid is 16, that equity holding would drop to around 50% to become more conservative. This change in allocation is done automatically. You don't have to do a thing -- just keep contributing.