How College Savings Plans Ease the Worry

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Worth Applying

State governments guarantee investments in prepaid tuition plans they sponsor, the SEC says, and they usually have residency requirements.

"The virtue to this approach is you eliminate your own investment risk, assuming the plan doesn't have any financial problems, but you're not making any money on your investment," Kitces says. "However, you are paying for future costs at today's prices."

Generally, these plans allow people saving for college to purchase units or credits at certain colleges and universities for tuition, and they are usually state-specific. Though the tuition costs are locked in, most plans typically only cover tuition and fees. Some plans do offer a room-and-board option.

Investing in college savings plans does limit the amount of need-based financial aid for which a saver can qualify, but the only way to find out about eligibility is to fill out the Free Application for Federal Student Aid, says Sallie Mae, a student loan provider. So, even if you think your income disqualifies you, apply anyway. There are a number of factors used in the federal formula for determining aid. Only a small percentage of parental assets are expected to be contributed toward education (meaning you won't have to sacrifice home equity or retirement savings). The greater the number of college students in your family, the more aid you are likely to get. And even part-time students can receive financial aid.

Parental Assets

As of July 1, 2006, assets held in both types of 529 plans are now treated as parental assets when calculating the amount a family is expected to contribute toward the cost of college, the SEC says. Previously, benefits from prepaid tuition plans had not been considered parental assets, and "typically reduced need-based financial aid on a dollar-for-dollar basis." College savings plans' assets had been afforded more favorable financial aid consideration.

And there's other good news. Sallie Mae says financial aid is widely available—more than $78 billion was budgeted in 2006 for more than nine million students. The figure excludes state and private scholarships and grants that colleges administer or award themselves, Sallie Mae adds.

Though 529 plans are becoming the most well-known, there are other tax-advantaged ways to save for college: Coverdell education savings accounts, Uniform Gifts to Minors Act (UGMA) accounts, Uniform Transfers to Minors Act (UTMA) accounts, tax-exempt municipal securities, savings bonds, and savings in a taxable account.

Sanders is a reporter for Standard & Poor's Global Editorial Operations.