SM: College-Savings Plans

Section 529 plans come in two models: The college savings plan and the prepaid tuition plan. Of the two, college savings plans are considerably more flexible, making them a better choice for most families. Here's how they work.

College Resources

• Consolidating Student Loans
• Best Student Loan Options
• 529 Plan Calculator for College Savings

College-savings plans are a little bit like a very restricted 401(k). (Although with a college-savings plan you are contributing after-tax dollars, while with a 401(k) contributions are generally pretax.) In other words, you contribute money to the plan, which is then invested in some sort of savings vehicle -- typically mutual funds. Many of these plans offer stock funds when a child is quite young, which will then be transferred to more conservative investments, like bond funds, as the child gets closer to college age. Of course, unlike the prepaid tuition plans, there are no guarantees that your money will grow large enough to cover your tuition bills. But should you invest in a good plan, the returns (combined with the tax-free withdrawals) certainly give you a fighting chance. Also, these plans aren't strictly geared toward in-state schools, but are meant to be applied toward whichever school your child chooses to attend.

For stay-at-home mom Becky Harvey of Oxford, Mass., investing in a college-savings plan was a much wiser choice than a prepaid tuition plan. When her five- and six-year-old sons were first born, Harvey and her husband Greg began investing on their behalf. They initially used a prepaid plan sponsored by the state of Massachusetts, but they've since begun contributing instead to the U. Investing Plan, Massachusetts' college-savings plan, which is run by Fidelity. "Since our kids are so young, I figure with our long investment horizon that we'll do better in this type of plan," says Harvey. "Sure, you lose some stability, but the way I see it, the money we are contributing today will help us buy low and sell high."

These days it seems pretty much every major fund family, including T. Rowe Price, Fidelity, Vanguard and TIAA-CREF, has partnered up with at least one state. And since most college-savings plans allow you to invest across state lines, this means that if you don't like the plan in your home state, you can look elsewhere and most likely go with a fund family that you already trust. (You could, however, lose out on some state-tax benefits.)

Keep in mind, investing in a college-savings plan could also affect your financial-aid eligibility, although in a different way than a prepaid tuition plan. College-savings plans are typically viewed as a parental asset, rather than a child's. And that means that a financial-aid officer would count a maximum of 5.6% of those assets toward your financial-aid eligibility, says CPA Rick Darvis of College Planning, Inc.

No matter what, don't let the fear of hurting your child's eligibility for financial aid paralyze you from developing a sound savings strategy. Remember, a lot of financial aid comes in the form of student loans, which means you'll save youself (or your child) some money by planning ahead.

Read on for more on prepaid tuition plans.