They haven't been publicized much, and a lot of advisors-let alone individuals-haven't heard about them yet. But make no mistake about it, 529 college savings plans are blooming across the nation faster than crocuses in spring.

"I think, on a relative basis, few advisors are aware of them, but that's changing over time. These programs are not easy to understand, and the fact that there's such a variety of them out there makes comparisons pretty tricky. But there's certainly a marketing opportunity for advisors who can develop knowledge in the area," says Joseph Hurley, a CPA and a partner with Bonadio & Co. in Pittstown, N.Y. Hurley has written a book and operates a Web site, www.savingforcollege.com, on 529 plans, which include prepaid tuition and savings plans. Both kinds can be established only by states.

The savings plans are gaining rapidly in popularity because they provide attractive benefits for people who want to invest for higher-education expenses. Anyone can open an account and name any person as the beneficiary-even himself or herself. The accounts now have about $2.5 billion in them, and projections are that number will grow to $100 billion in five years, says Nicolette Angelos, director of marketing for Schwab Institutional.

On December 15, Charles Schwab & Co. started distributing Kansas' Learning Quest plan, managed by American Century Investments, to its investment-advisor and retail clients.

A key benefit is that earnings aren't taxed until they are withdrawn, and even when income is taken out, it's taxed at the student's rate. And if Congress approves proposed legislation that would make earnings tax-exempt, not just tax-deferred, 529 savings plans will explode in popularity, observers say.

The plans offer benefits for parents at all income levels. In addition to state-tax deductions, some states provide scholarships or matching funds if the participant meets certain income requirements. They are more flexible than prepaid tuition plans, which require money saved to be used at particular schools. The 529 savings plans also can be powerful tools for affluent savers, who don't qualify for other tax-advantaged savings options. For example, couples whose adjusted gross income is $160,000 or more can't make contributions to education IRAs. Not only that, but 529 savings plans also allow far more to be contributed. Only $500 a year can be put into an education IRA, but many college savings plans allow total contributions of well over $100,000.

Other benefits, which may be of particular interest to grandparents, are that contributions are considered gifts to the beneficiary and are removed from the account owner's taxable estate. The gift-tax exclusion allows $10,000 to be given tax free annually to any individual, and savings-plan account owners can accelerate five years worth of the exclusion so that $50,000 can be contributed in one year and will immediately be removed from their estates. Not only that, but account owners retain control over the plans, so they decide when distributions are made, can chose to take back the money or can transfer the balance to another beneficiary.

Despite all their benefits, college savings plans do have some limitations, and many advisors recommend 529 plans represent only one element of a college savings strategy. For example, some people may find investment options too limited. Also, participants can't direct their investments as they can in brokerage or mutual fund accounts. Once the account holder picks an investment option, it usually can't be changed, although some plans allow new money to be invested differently. A 10% penalty is paid on any earnings not spent on qualified education expenses. Because each state's plan is different, comparing and evaluating them can be complicated. Another concern: Money in the account may impact financial aid.

The plans were named after Internal Revenue Code Section 529, which was enacted by Congress with the 1996 Small Business Jobs Protection Act and amended by the 1997 Taypayer Relief Act. The law created special tax benefits for qualified state tuition programs, which include prepaid tuition plans and savings plans. Although Michigan introduced the first prepaid tuition program in 1986, and Kentucky offered the first pure savings plan in 1990, it was when Congress enacted section 529 a few years ago that savings plans began to proliferate.

Not only have more states created 529 savings plans, but many also have expanded them so nonresidents can participate and money saved can be used at colleges anywhere in the country. Many states also have increased investment options and have hired well-known mutual fund companies to manage the money, making the plans even more attractive. Some plans now offer state-tax benefits.

"They're becoming more popular because there are more plans now than there were a year ago. Any state that doesn't have a 529 savings plan has at least been thinking about putting one in place. More new investment companies are in the picture, so they are offering a greater range of investments. The distribution through brokers has started this year, so there are a handful of programs that brokers can sell and earn commissions on," says Hurley.

As of last month, 529 plans were being operated by 44 states, including 34 states that offer savings plans, according to Hurley's Web site. Of the 34 plans, 27 were open to nonresidents. The Web site, among other things, rates each state program for residents and nonresidents.

Advantages

Many advisors who specialize in college planning say they are excited about 529 savings plans because they offer benefits that haven't been available before. In fact, several advisors comment they've already opened 529 plans for their own children. In the last few months, they say, more clients have been asking about the plans, although people's level of knowledge about them is still very low. They believe the savings plans offer something for most clients, regardless of income.

"I think they're growing in popularity because they provide a very user-friendly way to save for college. It offers a family the opportunity to make a small contribution on a regular basis, and for other families, we can make large contributions and get the money out of the estate," says Judy C. Miller, a CFP and principal of College Solutions in Alameda, Calif. Her financial-advisory firm focuses exclusively on college planning.

For example, with Kansas Learning Quest plan, residents can contribute as little as $25 a month, and nonresidents, $50 a month. "Even if you're cutting coupons to buy diapers, you might be able to squeeze that into your budget," notes Beth Randolph Turner, spokesman for Kansas City, Mo.-based American Century Investments, which manages the plan.

Barbara Jones, a CPA and CFP who manages Kerkering, Barberio & Co. in Sarasota, Fla., also favors the plans. "I think they're a really good vehicle in comparison to what's been out there in the past. They have a lot of options and have characteristics that are better than anything that's been out there before ... One of the key things is the account owner keeps control over the funds, so it's an ideal account for a grandparent to establish when a child is born," she says. With custodial accounts, such as UTMAs, often used by parents and grandparents to save for college expenses, the money accumulated goes to the child at a certain age, regardless of how the child wants to use the funds, Jones notes. "I think that seems to be a concern with people, if you give money away and totally lose control," and 529 plans address that problem," she says.

In fact, says Steven M. Klane, a CPA in Minneapolis, "It's one of the few opportunities in the tax code where a contribution can qualify as a gift to a child and you maintain control. If the beneficiary doesn't go to college, the account owner can change the beneficiary to another member of the family ... Currently, there's no maximum time to take out the funds, so that would allow the account to grow for many more years."

Klane, who owns Steven M. Klane Ltd., says another key element is that earnings grow tax deferred, and less tax will likely be paid when the money is withdrawn since it's taxed at the student rate, which in most cases will be lower than the parents' or grandparents' rates.

James H. Christie, a CFP with Charon Planning in Newark, N.J., maintains a big plus of 529 savings plans is that they don't have income limitations. His firm specializes in benefits planning, and most of his clients are corporate executives earning $150,000 plus, so they don't qualify for a lot of college-savings or financial-aid programs. Many of his clients' employers offer nonqualified deferred-compensation plans, which can be a good way to save for college costs, he says. "But I'm a big fan of not putting all your eggs in one basket. Nonqualified deferred-compensation plans are wonderful for highly compensated individuals, who typically are earning more than $125,000, But there are some restrictions, such as you have to decide before you defer the money when it will be paid out," says Christie. He thinks many individuals who have nonqualified deferred-compensation plans should establish 529 savings plans, too.

Great, But Not Perfect

Although most advisors think the positives of 529 savings plans overwhelmingly outweigh the negatives, they add that clients need to consider the limitations and how they affect their own situations.

"I was very much on the fence when they first came out, but I'm starting to swing around. But you need to know the person's financial-aid situation and make sure it isn't affected in a draconian way," says Kathleen Dollard, president of Nashoba Financial Planning in Boxborough, Mass. She recently opened an account for her 16-year-old son and soon plans to open one for her other son, who is 14.

For federal financial-aid calculations, assets in 529 savings plans belong to the account holder rather than to the student. Parents' assets don't weigh as heavily into those calculations as assets belonging to students. Still, Dollard says, private colleges that give their own financial-aid awards could treat 529 assets as the child's when doing their own calculations. She and other advisors agree it's important to do financial-aid estimates for clients to see what the impact of various savings options are. "Someone with over $100,000 in income with one or two kids won't qualify for a lot of financial aid anyway. But if you have three kids in college at the same time, that would make a difference. You really need to run the numbers," Dollard says. In some cases, she says, the tax benefits gained from a 529 plan may be outweighed by the loss in financial aid.

Still, Miller comments, savings in a 529 plan will affect financial aid less than savings in custodial accounts, which are treated as the child's assets in financial-aid calculations. She that adds the parents' adjusted gross income affects financial-aid awards much more dramatically than assets.

Hurley says one criticism of 529 savings plans that often comes up is that federal requirements don't allow participants to direct their investments. Participants can choose investment tracks, such as aggressive, moderate or conservative, and many plans offer options that adjust the mix of equities and fixed-income investments to make the portfolio more conservative as the child gets closer to college age. Still, account owners can't pick or adjust the individual stocks, bonds or other investments that are part of the portfolio. "They want the state to be responsible for investment decisions. It's a stupid rule ... They just see it as a program that's on the shoulders of the states to make college investment decisions for beneficiaries. But like I say, I don't see any good reason for it," Hurley says.

Klane sees an issue for account owners when earnings are withdrawn. "When the earnings come out, even though they are taxed at the student's rate, the client is probably going to have to pay those taxes because the student is not earning any money. The tax liability has to be accounted for, and the parents will probably have to gift the tax to the child," Klane says.

Christie believes 529 plans would be even better if changes were made in federal law so companies would want to offer them to their employees. "I would like to see, down the road, a change in the tax code to make 529 plans similar to 401(k)s," he says, with contributions permitted pretax and employers making matches through vesting programs. But the way the law is written now, it's difficult to make employer-sponsored plans attractive. "Now, with an employer plan, you'd get the tax deferral on the gains, but the entire amount paid out would be taxable as income to the employee, and gains would still be taxable to the beneficiary," he says. Such employer-sponsored plans haven't been tested yet, but they don't seem as though they'd be very beneficial, he adds.

Other glitches might become apparent after the plans are around a little longer. For example, since the plans are so new, most account holders don't know how the withdrawal rules will work for them in practice.

Evaluating Plans

Because states have different plans, it's important for advisors to look at which one offers the most benefits for particular clients."The programs that get high ratings are the ones that incorporate all the flexibility allowed under federal law. I prefer not to see a state add additional restrictions that federal law doesn't require," Hurley comments. "I like to see good solid investment options available under the program. I want to make sure the program is administered in a good fashion, that the materials are good. The TIAA-CREF program in a number of states, like New York, Missouri and California, is good. Merrill Lynch has a good program in Maine. Fidelity is doing well in New Hampshire, although it doesn't offer all the options of some of the other programs."

It's important to see whether the state in which the potential account owner lives offers any tax benefits for participating that he or she wouldn't get in another program, he adds. "More and more, that's the case. In New York, for example, I get to deduct up to $10,000 in contributions if I use the New York program. I'm not going to get that in another program," Hurley says.

Other benefits also may make a plan stand out for certain clients. "For example, Minnesota is coming out with a plan in the first quarter of 2001, and Minnesota has decided to provide a match that will act like a 401(k) that will match the contribution," Klane says. "But that match is only for taxpayers who make less than $80,000 a year. For those who make more than $80,000, they might want to look to another state's plan for different investment options or more flexibility."

Another important factor is who manages the plan. "There are different investment managers and choices, and different management fees among those choices. TIAA-CREF, for example, manages nine or 10 plans, but management fees vary. Some states offer plans with fees as low as 65 basis points and some are as high as 110 basis points," Klane says. As far as investment choices, many states offer age-based plans in which the younger the beneficiary, the greater the allocation to equities, he continues. As the child gets older, the plan is weighted more toward fixed-income securities. Some states have a 100% equity option, some are 100% aggressive, and others offer a guaranteed-income options that pays 3% to 4%, Klane says.

How easy a 529 savings program is to set up can also be important, says Howard Kaufman, president of Financial Advisors Ltd. in Buffalo Grove, Ill. "When I talk to clients, I ask them if they have any real preferences for companies they want to work with," says Kaufman, who has established plans for his three children, who range in age from 5 to 13.

Other Issues

What might affect the plans in the future? Congress making earnings tax exempt on 529 savings plans would be a positive, but other actions might decrease their desirability. "If the government increases the amount you can contribute to an IRA to $5,000, the dollars that might otherwise go to education savings might go there. They could increase the contributions for education IRAs to $2,000. They could change the tax-rate structure and decrease capital gains. If 529 plans remained taxable as ordinary income to the child, then custodial plans invested in mutual funds might give a better answer," Hurley says.

He adds that the IRS is coming out with final regulations on 529 plans at some point, and the agency could tighten up the estate and gift-tax rules that relate to the plans. Eliminating or reducing estate taxes might affect the amount of money put into the plans, but that actually might increase contributions because people wouldn't have to be concerned about gift-tax exclusions and how to use them, he says.

Eventually, Hurley believes, one type of plan will dominate what's offered by the states, making them much easier to understand. Plans already are moving in that direction. "State legislators, when they came up with the original bills creating the plans, put in excess baggage, but they've started taking that out. California is a good example. They had a lot of unnecessary restrictions in the original legislation, and they've been removing that. States are approaching a similar model, one that really incorporates all the flexibility available."