Qualified tuition plans allow you to set up a tax-advantaged account for your child's college education. There are two types of Section 529 plans: prepaid tuition programs and college savings plans.

	Prepaid tuition programs let you lock in today's tuition costs by purchasing tuition credits or certificates that a student redeems when he starts college. Prior law limited these plans to state-run plans. However, The 2001 Tax Relief Act permits education institutions to establish and maintain prepaid tuition plans beginning in 2002.
	College savings plans let you make contributions to a state-sponsored savings account to build a fund for your child's college expenses. These accounts are generally managed by a private mutual fund company.

How do they work?

	Make a gift to set up an account. You start by setting up a qualified tuition plan account and naming your child (or anyone else) as the beneficiary. Your contribution is considered a gift. Your contributions qualify for the $11,000 annual tax-free gift exclusion ($22,000 for married couples making a joint gift).  Special rules for 529 plans let you average your gift over five years. This means married couples can make a $110,000 joint gift and individuals can make a $55,000 gift in a single year, without incurring gift tax. However, you cannot make additional gifts to your child for five years, or you may owe gift tax.
	Your contribution is limited. You aren't permitted to make contributions to a 529 plan beyond what is necessary to pay for your child's college expenses. Each plan sets its own limit. Generally, your contributions to a prepaid tuition program will be limited to the number of credit hours that it takes to obtain a degree. Savings plans usually limit your contributions to the estimated cost to attend the colleges eligible under that state's plan. Most plans allow you to make either a lump sum contribution or a series of monthly contributions. All contributions must be made in cash; you can't contribute shares of stock or other property to these plans.
	You remain in control. You cannot choose the investments in the fund — a fund manager does this. However, you do remain in charge of all withdrawal decisions. You can allow your child to make withdrawals to pay for college expenses. If your plan permits it, you can change the beneficiary to another family member without losing the tax benefits. If you change your mind about maintaining the account, you can even request a refund (tax and penalties will apply).  Other types of accounts, such as education savings accounts (previously called education IRAs) and custodial accounts, don't offer this control. Once you set up these accounts, your child is the legal owner. As long as your child is a minor, you may control the investment and withdrawal decisions. However, in most cases your child can withdraw funds, for any purpose, when he or she reaches legal age (18 or 21 in most states).
	Your child can withdraw money to pay for college expenses. Section 529 funds must be used for qualified higher education expenses, such as tuition, fees, books, and supplies. They can also be used to cover certain room and board expenses, as long as your child attends school at least half-time. If your child receives a scholarship, you can request a penalty-free refund up to the amount of the scholarship. In addition, you can withdraw the funds if your child becomes disabled or dies.  If the funds are withdrawn for any other purpose, you (not your child) pay tax on the earnings that have accumulated in the fund. The new law repealed the required plan-imposed penalty and replaced it with a 10% excise tax. However, your plan may still charge withdrawal fees.
	You can change plans. Prior law allowed a tax-free and penalty-free rollover from a QTP for your child to a QTP for another family member. Now you can make a tax-free rollover to another plan with the same beneficiary. That allows you to move your child's plan to another state's plan or to change your child's state-run plan to one run by a private institution without losing the tax benefits. This tax-free rollover treatment only applies to one transfer within any 12-month period.

What are the benefits?
 

	Section 529 plans offer tax benefits. Your contribution is not tax-deductible, but your investment grows tax-deferred. That allows your money to grow faster than a similar investment in a taxable account. Qualified distributions from state-run plans are tax-free. After 2003, this tax-free status applies to qualified distributions from nonstate plans as well.
	Compare Section 529 plans to other education saving options. Qualified tuition programs have some advantages over other tax-favored ways to save for college.  Education savings accounts permit you to set aside up to $2,000 per year in a child's name, much less than what you're able to put into 529 plans. You can't contribute to an education savings account once your adjusted gross income reaches certain levels. Anyone can contribute to a 529 plan — it doesn't matter how much you earn.  Education savings bond interest (Series EE and Series I bonds issued after 1989) is tax-free if you meet certain requirements and use the funds to pay for college tuition and fees. The tax status of 529 plans depends only on how the funds are used.  Custodial accounts usually produce taxable income for your child. That generally means preparing tax returns and paying taxes each year. The money inside a Section 529 plan grows tax-deferred, and after 2001, the earnings are tax-free if the funds are used to pay for qualified college expenses.
	Section 529 plans offer an estate planning opportunity. The 2001 Tax Relief Act gradually reduces estate taxes over the coming years and repeals them entirely in 2010. In the meantime, Section 529 plans let wealthy parents or grandparents transfer wealth out of an estate and into an account a child can use to pay for college expenses.

What are the disadvantages?

While these plans offer an attractive alternative to other college funding plans, they are not without drawbacks. There are a number of factors you should consider before you invest in a qualified tuition plan. 

	Substantial penalties apply to nonqualified withdrawals. What if there are funds left in the account after your child completes his college education? What if you change your mind about sending your child to college? What if an emergency arises, and you need the funds for yourself? You may request a refund, and the account will be refunded according to your plan's policy. However, any nonqualified distributions will be subject to withdrawal fees and penalties. You'll also owe income tax on the distribution.
	Watch out for the GST trap. Generally, changing beneficiaries to another member of the family doesn't trigger tax. However, when you change a beneficiary to a family member that is a generation below that beneficiary, the generation-skipping tax (GST) will apply. For example, you change the beneficiary from your child to your grandchild. The GST is designed to ensure that property does not skip a generation without a transfer tax being imposed.
	Your state plan may not meet your investment expectations. You should choose from among the plans available one that meets your risk tolerance and performance expectations. But what if you are unhappy with a plan's investment performance? If your plan allows rollovers, you can move the funds into another qualified tuition plan. If you simply request a refund, you'll have to pay income tax and penalties on the distribution.

Do your homework.

The same federal income tax rules apply to all qualified tuition plans. However, each plan has unique features. Nearly every state offers a 529 plan. For details on each state's prepaid tuition program or college savings plan, visit www.collegesavings.org. Beginning in 2002, private institutions can also offer plans. Here are some items you should compare when you evaluate different plans.

	State income taxes.
	Investment return.
	Enrollment fees.
	Maximum contributions.
	Flexibility in making contributions.
	Withdrawal fees and penalties.
	Transferability to another beneficiary or another qualified plan.
	Choice of schools.
	Participation by nonresidents.
	Beneficiary age restrictions.
	Covered education expenses, including restrictions on room and board.

State tuition plans provide an attractive and tax-favored way to save for college. However, they are not the right choice for everyone. Give us a call to discuss all your education funding options. We can help you choose a plan of action that is suitable in your situation.