On June 7, President Bush signed the 2001 Tax Relief Act that will become effective in 2002. Among other provisions, the law provides full federal income tax exemptions for 529 plans. Currently, 529 plan beneficiaries (students) are required to report withdrawals from 529 plans made for education expenses as income. The new bill provides tax relief for beneficiaries as long as the withdrawal is used for qualified college costs. The law sunsets in 2010, at which time Congress will vote whether or not to reenact it.

Named after Section 529 of the Internal Revenue Code, state-sponsored college savings plans are becoming increasingly popular. Joseph Hurley, author of "The Best Way to Save for College" and chief executive of www.savingforcollege.com, estimates that by the end of 2001, 529 savings plan assets will reach 10 billion dollars.

There are two types of 529 plans: prepaid tuition plans and college savings plans. Prepaid tuition plans allow donors to lock in current tuition rates by paying now for future education costs. The more popular option is college savings plans, which are managed by an investment firm. Some states have both, some have one or the other. A handful will enact programs this year and just two states - Georgia and South Dakota - have no legislation to implement a program.

Hurley declares that "the Education IRA, with its annual contribution cap raised from $500 to $2,000 and improved in other ways under the same bill, pales in comparison to the power of the 529 plan."

So what makes them so wonderful? The advantages of 529 plans as they stand now are numerous:

• The donor has full control of the account, not the beneficiary.
• The account is transferable to another beneficiary.
• The donor/contributor can rely on the state to make the investments.
• Everyone is eligible. There are no income or age restrictions. In many states you can be your own beneficiary and fund your own education.
• Donors may have 529 accounts in more than one state, enabling them to shop for the best plan. Only a handful of states mandate residency requirements.
• The funds may be used at any accredited college or university in the entire country. 
• As little as $25 a month or as much as $250,000* a year may be donated to a single account. In comparison, the Education IRA is currently limited to $500.

There are more advantages once the law becomes effective in 2002:

• Significant income tax breaks. The investment grows tax-free and, as mentioned earlier, is tax-exempt when withdrawn by the beneficiary for college or graduate school expenses. Earnings on 529 plans withdrawn after Dec. 31, 2001 are never subject to federal income taxes and are therefore mostly exempt from state income tax as well.
• A tax- and penalty-free rollover to another state 529 plan is allowed once every 12 months.

Alas, there are disadvantages to 529 plans. There is a 10 percent penalty on earnings if the money is withdrawn for non-qualified expenses. Also, once you choose an investment you have to stick with it for at least one year. Investments cannot be made in both a 529 plan and an Education IRA for the same beneficiary within the same year. And due to the new law, tax reporting for 529 plans will be more complicated come 2002.

Contact the State Treasurer's Office to review your state's 529 program. 

Also see Expert Helps Parents Decide If College Saving Plans Are Right for Them