Tax free still trumps taxable accounts just about every time.

Have 529 plans-the not-so-long-ago media darlings of education savings-lost their shine?

First, the plans were stung by the same angry stock market that wounded nearly all U.S. equity investments over the past three years. Then President Bush signed a $350 billion tax bill into law, putting taxable accounts into seeming contention for the education dollars that had been flowing into 529 plans.

Created in 1996, 529 plans only began to take off in 2001 when Congress significantly increased their tax benefits. By the end of last year, 3.1 million accounts with more than $20 billion in assets were open, according to Boston-based Cerulli Associates. That's up from $3.1 billion in 556,000 accounts just two years earlier. With college costs expected to soar in 18 years to more than $100,000 for public college tuition and more than $250,000 for private college, parents need all the help they can get socking away even part of the tuition tab they're expecting to foot.

But now, with the new tax act reducing capital gains and dividend rates to almost nonexistent levels for folks with little or no income (children and grandchildren often fall into this tax bracket), taxable accounts put in kids' names can be used as potentially tax-efficient vehicles for college savings. We say potentially because there are a number of caveats to that tax-efficiency, which we'll discuss. The point is that 529 plans must be used for education purposes to qualify for tax- and penalty-free distributions, while taxable accounts may used however an investor sees fit, should a change of plan or an emergency arise.

The flexibility and less onerous taxes seem to be attracting planners and investors to taxable education savings accounts. "As an advisor, I am not recommending 529 plans until I see clients put enough assets into taxable accounts," says Patrick Horan, managing partner of Horan & Associates Financial Advisors Ltd. in Towson, Md. "I think 529 plans are great, but what if your plans don't work out? What if you lose your job, or the kids don't want to go to school or get scholarships and don't need the money? It's just silly to have the tax tail wag the dog."

Investors need to weigh the "tax risks" of these plans, Horan says, especially now that even the top rates for capital gains and dividends have been reduced to 15%. To him, the major risk with 529 plans is the possibility of having to pull money out early and use it for something other than education. Investors who do that pay income tax and a 10% penalty on earnings.

"Time and time again I see people come in who were using tax strategies that now, because of a layoff or some other situation, weren't the right ones for them," says Horan. A handful of his clients have drawn down 401(k) plan assets after losing their jobs. The tax treatment of early withdrawals from 401(k)s and 529 plans is identical, although many 401(k) participants can borrow their money to avoid the taxes and penalties. The planner says he likes clients to accumulate as much as $500,000 in taxable accounts before he'll recommend a 529 plan.

But not all planners or college savings experts agree with Horan. In fact, many still believe that the overall benefits of 529 plans trump taxable accounts on many fronts. "I think investors always have to evaluate all of their options, but I think that while there are competing options for savings, 529 plans still shine," says Joseph Hurley, founder and CEO of Savingforcollege.com, in Pittsford, N.Y., a nationally known information source for investors and planners. Hurley routinely evaluates all the bells and whistles on competing plans, but he still believes that the tax-deferred growth in 529s, their tax-free distributions and the continuing control parents get over the accounts make them the best choice for most households.

While taxable accounts, with their new low tax rates, can sound like a great education savings opportunity, the case for them often ignores some extremely pertinent and potentially costly facts.

This is especially true when it comes to rebalancing or changing investment options in a taxable college savings plan. With a taxable account, the investor will get hit with income tax or capital gain rates depending on when they sell, all the while paying taxes on whatever dividends are paid. True, the capital gains and dividend rates are 5% for the lowest income brackets into which, presumably, pre-college age kids will fall. Still, even with lower rates, the taxes on even a fairly actively managed taxable account can take quite a toll over a ten- or 15-year investment period, says Carol Zoubek, director of investments at New England Financial Planning Group in Burlington, Mass.

And what happens when Junior withdraws $15,000 or $25,000 or even $50,000 from his taxable accounts in the course of one year, to pay the first year of tuition and other educational expenses? Simply put, he'll be taxed in a higher bracket that year and every subsequent year he makes a significant withdrawal.

Contrast that tax scenario with a 529 plan, in which investors can routinely change investments, move from plan to plan within a state program and transfer entire balances to a new state plan every 12 months without incurring any tax. (Some plans have instituted one-time withdrawal penalties ranging from $25 to $35 to staunch investment flows.)

Another tax benefit with many 529 plans? Investors in 25 states can take an annual state income tax deduction for contributions. In some states, that deduction is limited by the plan's maximum contribution cap, which typically ranges from $225,000 to $305,000, Hurley says. These write-offs can be especially meaningful for parents and grandparents in higher tax brackets who can use the deductions.

To encourage more education savings and fatter state plan coffers, a growing number of states also are offering matching contributions to state residents.

A downside to taxable accounts is that when they are put in kids' names, parents must relinquish control over how the money is used. In contrast, "529s are a big bonus for high-income people, and the money doesn't automatically go to kids when they reach college age," says Bill Driscoll, president of Driscoll Financial in Plymouth, Mass. "The plans are also really, really important tools for middle-income investors who are going to be just over the income limits for financial aid."

The long-time planner brings up two important benefits to the 529 plan. First, unlike taxable accounts or even Coverdell or UGMA or UTMA accounts, the money remains in the account holder's control-namely the child's parents or grandparents. If a child decides not to go to college, the household can transfer the account to another family member should he or she want to go to school.

Another benefit of 529 plans is the less onerous impact they have when it comes to calculating a child's financial aid eligibility. Unlike taxable accounts (or for that matter any accounts that are put in the child's name), 529s are counted for financial aid purposes as the parents' assets. In contrast, because children are the legal owners of the Coverdell and other accounts, they are assessed at a higher rate when applying for financial aid.

Driscoll says all these benefits have focused more, not less, attention on 529 plans. He has several clients with students approaching college aid who have decided to take out home equity loans to fund stable-value or fixed-income accounts in 529 plans. While Driscoll says he didn't recommend the move, he can admire the beauty in it. "They're saying, 'This is an expense we have to fund one way or another. Why not be as smart about it as possible?' This allows them to tap a small part of what has been a huge run-up in home equity at historically low rates. They get a tax write-off in the process, which they can use because they're in the highest tax brackets," Driscoll says.

For younger, less wealthy clients, especially those who often opt to fund college savings over their own retirement, Driscoll has found a tradeoff that seems to work: He has them fund Roth IRAs first. They'll be able to tap all contributions for college costs if they need to, while at the same time socking money away for retirement. "My goal is that when they start to see the Roth account grow, they'll want to start the 529 and not tap their retirement assets," Driscoll adds.

Finding the best 529 options, whether in state if there is sufficient benefit from a state tax deduction or out of state if there is no such tax benefit, is also getting easier with the advent of two new comparison and rating tools for advisors. Both Hurley and Morningstar have introduced new programs advisors can use to sort plans and find the ones with the best performance and lowest expenses. Hurley's program is called 529 Pro Solutions (www.savingforcollege.com) and Morningstar's is called the Morningstar 529 Advisor (www.MorningstarAdvisor.com). Both have annual subscriptions of $395.

Hurley says states are getting more discriminating when it comes to picking plans and maintaining contracts with fund companies that can deliver performance at a reasonable price. A recent case in point: New York state decided to replace TIAA-CREF, a fund provider known for its low costs, with Vanguard, a fund company known for its even lower costs, in August.

With 80 different state programs and numerous other sub-plans in the 529 arsenal, due diligence and historical justification of 529 plan selection will only get more competitive. "I hope advisors are doing apples-to-apples comparisons when it comes to expenses, risk and performance," says Langdon Hughes, a mutual funds analyst who specializes in 529 plans with Morningstar in Chicago. "I also hope they're comparing plans with similar asset allocations. Frankly, there are some really expensive programs out there and some that aren't, so it can definitely pay to shop around."