Saving for college has always been a difficult problem for families. The introduction of state-sponsored college savings plans has created a new type of investment vehicle to help families address this growing need. In 1997 federal tax legislation created Section 529 of the Internal Revenue Code. State college savings programs created under this code, commonly called “529 Plans” offer unique features and benefits that can make them an attractive investment for families. In 2001, the federal government went even further, making the earning on these programs exempt from federal taxation if the funds are used to pay for college expenses. With these changes, effective in 2002, these programs have now become the best way to save for college.

Nearly every state now offers a 529 Plan, and each program slightly differs. Most programs are open to residents of any state. Some states provide special incentives for residents of their states. These can include state tax deductions for contributions or advantages when the funds are used to pay for college. A family should review the unique features of their state program when comparing it to others.

There are several features that all the state 529 Plans have in common:

• 529 Plans provide tax-deferred earnings from the time invested until the money is used to pay for college. When the funds are withdrawn to pay for college expenses, the earnings are free of federal income tax and also free from taxation in most states. Like the estate tax, the federal exemption expires in 2011, at which time the earnings will become taxable upon withdrawal, although at the student’s tax rate – usually lower than the parents – unless Congress reauthorizes the exemption.

• If the money saved is not used for college costs the earnings will be subject to a 10 percent penalty, in addition to state and federal taxation. If the student receives a scholarship, an amount equal to the scholarship is not subject to this penalty.

• The funds are owned and controlled by the account contributor and not the child beneficiary. It is the contributor who owns the account who decides how the funds are to be used. At any time, the beneficiary can be changed, usually for a small fee. Or the funds can be withdrawn at any time, although subject to the 10 percent penalty and taxation.

• There are no income limits on eligibility to contribute to 529 Plans.

• The maximum amount which can be contributed varies by state. Generally the amount is equal to five years of college expenses with most limits ranging from $100,000 to more than $260,000.

• The plans allow the changing of beneficiaries, so if one child doesn’t attend college the account can be used for another sibling or blood relative, including stepchildren.

• The investment vehicle is almost always some combination of mutual funds. There are usually different investment options for participants to choose among. Every program offers age-based asset allocation strategies. This strategy has the invested funds shift periodically over the years as the child ages. The funds move from a more aggressive initial overweighting in equities when the child is young to a more conservation overweighting in fixed income investments as the child nears college age. Many states offer a static, unchangeable allocation whereby the allocation to equities or fixed income investments or a percentage of each remains the same regardless of the child’s age. Account contributors can choose a more aggressive or conservative strategy depending on their personal investment preference. For added flexibility, this choice can be changed once per year.

• A unique provision of tax code for 529 Plans is the ability to make a special election to carry forward a lump sum gift over a five-year period. This allows a person to make a $55,000 ($110,000 for a married couple) contribution gift-tax free, although no other gifts to that beneficiary can be made during the ensuing five year period. This special election should be carefully considered as it could have an important estate planning impact.

• The funds can be used for the higher education costs – both graduate and undergraduate – of any accredited college in the U.S. and some foreign institutions.

• The invested funds can be used for qualified education expenses – tuition and fees, books supplies and equipment and room and board, essentially those expenses required for college attendance.

There is an organization called the College Savings Plan Network (CSPN), which is the umbrella organization for all of the state sponsored college savings programs. The CSPN acts as the central source of information on every state plan. They can be found on the Internet at www.collegesavings.org. This Web site provides the toll-free numbers and links to each state’s college savings programs Web site.

This is a brief overview of the many advantages of Section 529 Plans. Each state plan has different features and benefits to consider.

Marc A. Pellerin is an associate vice president and investment advisor with Advest Inc. in Lewiston.