Saving for College 529 plans swell after rules are eased

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When it comes to saving for college, simple is always better. Just ask Uncle Sam.

Shortly after the federal government simplified rules concerning 529 college savings plans earlier this year, interest in these tax-deferred savings vehicles soared.

In the first quarter, 529 plan assets swelled 38 percent to $75.1 billion, according to the Financial Research Corp., which tracks financial data.

"This is a big deal," says Brian Boswell, an analyst with FRC, "mainly because we had been seeing interest in 529s wane a bit in the past few years."

While stock market gains accounted for some of the increase in 529 assets, they weren't the only factor. The broad U.S. stock market rose only around 14 percent from the end of the first quarter of 2005 to end of the same period this year.

Clearly, parents are paying more attention to 529 plans. And why shouldn't they? College expenses continue to rise at a significantly faster clip than inflation. And now that the federal government has begun to remove some of the confusion surrounding the alphabet soup of college savings vehicles, the system is becoming easier for parents to understand.

For example, earlier this year Uncle Sam leveled the financial aid playing field between 529 savings plans (which are sort of like 401[k]'s for college savings) and 529 prepaid tuition plans (which allow parents to lock in tomorrow's education at today's prices).

For years, the federal financial aid system regarded money held in a self-directed 529 savings plan as a parental asset, which is good for financial aid seekers. That's because only 5.6 percent of parental assets are expected to be used to pay for college. On the other hand, money held in a 529 prepaid plan was terrible when it came to qualifying for aid, as it reduced financial aid eligibility dollar for dollar.

Not anymore. Starting July 1, assets held in a prepaid plan will also be considered a parental asset. This means that almost all the major tax-advantaged college savings vehicles-529 savings plans, Coverdell education savings accounts (which are sort of like IRAs for school), and 529 prepaid accounts-are treated exactly the same when it comes to aid.

The only college savings vehicle that is considered detrimental to financial aid seekers now is a traditional custodial account, such as Uniform Gifts to Minors Act accounts.

But here, too, the government recently made a change. Though money transferred from an UGMA to a 529 savings plan is still technically the child's asset, it will no longer be considered a student asset for the purposes of financial aid.