The Lowdown

With the average annual college tuition bill topping $4,000 at public, four-year colleges and universities, and as high as $19,500 at private, four-year schools, you may be wondering if you'll ever afford to send your kids. There are many ways you can gradually sock away cash for future college costs -- including Coverdell Education Savings Accounts (formerly known as Education IRAs), zero-coupon bonds, and custodial accounts. But figuring out which method is best can be as complicated as advanced calculus.

However, one type of savings tool -- state-sponsored college savings plans -- is a real standout. Though they've been criticized in the past for being too restrictive and wreaking havoc on students' financial aid prospects, they deserve a second look now that provisions in the recent tax law have improved them.

You may have heard of 529 Plans, an umbrella term used to describe both college savings plans and prepaid tuition programs. (Most states offer one or both types of plans.) Prepaid plans let parents lock in today's prices for tuition, room, and board by paying these college expenses up front, either in a lump sum or in installments. On the other hand, savings plans let you make monthly or quarterly contributions (as little as $15 or $20 per pay period through automatic payment programs in some states) to an account which the state invests on your behalf. Many states have top mutual fund companies (including Fidelity, T. Rowe Price, and TIAA-CREF) steering the investments, which are spread over a mix of stocks, bonds, and cash equivalents, depending on the age of the child.

Both types of plans generally let anyone (a parent, grandparent, relative, or friend) set up an account and make contributions, regardless of income. And most states set high ceilings on the amount you can put in -- as much as $200,000 or so in some states.

While prepaid plans are guaranteed to keep up with college cost increases -- which hit 5.7 percent at four-year public colleges in the 2003-2004 school year and 9.8 percent at private four-year schools, according to The College Board -- college savings plans are especially attractive because of their unlimited potential growth, particularly if you enroll when the child is very young. Furthermore, while money in either type of plan can typically be used to pay for expenses at any accredited college or university in the country, you may not be allowed to apply the full balance from a prepaid tuition account to an out-of-state school, depending on the state's rules.

Starting in 2004, private colleges and universities can establish similar prepayment or savings plans, and the distributions from the plans will be tax-free.