Changes add appeal to a college-savings plan

Weakened economy or not, college isn't getting any cheaper. But state-sponsored "529" college-savings plans are getting a lot more user-friendly, and could become a big source of college funds.

A 529 plan, named after that section of the IRS code, allows a sponsoring state to set up investment accounts that are meant to help pay for college. The donor puts money into an account, and the state - typically nowadays through a mutual-fund company that actually runs the plan - invests it in stocks or bonds in the hope of making enough money to pay for the ever-increasing cost of college.

The big difference between a 529 plan and a standard investment in mutual funds is tax breaks. In many of the 39 states that already operate 529 plans, annual contributions are tax-deferred. Michigan and Missouri, for instance, permit $10,000 write-offs to married couples filing jointly.

Better yet, thanks to recently passed tax-relief measures, qualifying withdrawals will be free of federal income taxes starting in 2002. Many states will follow suit and free up earnings from state taxes.

Besides that big tax windfall, lawmakers have made 529 plans more appealing by broadening their investment choices. Until September, Iowa offered one style of investing; now it offers four "tracks." They range from conservative to aggressive - and, from mostly stocks to mostly bonds - as investment choices.

Investors typically move from more- to less-aggressive tracks as the student approaches college age. And the IRS has just decided to allow account holders to change tracks once a year if they wish.

"It's definitely an improvement ... in offering more choices to investors," says Joe Hurley, author of "The Best Way to Save for College" and a leading authority on 529 plans. Mr. Hurley says he also likes two other tweaks that Congress has made to 529 plans. In the first instance, they have broadened the definition of family to include cousins, so money not spent by one student can be spent on a brother, sister, or now, a cousin.

Second, account holders can now transfer a 529 plan from one state to another. This is an important benefit to such a mobile society, especially since so many of the tax breaks are tied to the state of residency.

An existing benefit of 529 plans is that they provide a back-door way to retain control over the student's money. Traditional custodial accounts (also know as UTMA or UGMA accounts) require that ownership be given to the child once he or she reaches the age of majority - 18 or 21, depending on the state. A 529 skirts such arrangements, giving the donor the ability to ensure that the funds will be used for education.

If, for example, a youth named on an account decides to skip the undergraduate life, the money can be transferred to other family members with college expenses. (You can also spend the money yourself, but the earnings would be taxable, plus a 10 percent penalty.)

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