If your children are young—say, age 10 or younger—you may not want to make any big changes in your college savings program because of the economic downturn. No one knows exactly where the market is headed. But with eight years or more between now and college, you probably have time to make up any financial losses you suffered. And if you are just starting to save, at least you're buying in at low prices.
For most families, the best place to park these savings is in a 529 plan (the name derives from the section of the tax law that created them). A Fidelity Investments survey found that parents who save that way were on track to cover 40 percent of education costs, on average. All 50 states and the District of Columbia currently offer 529 plans. Their advantage is that you don't have to pay federal tax on investment earnings so long as the money goes to pay for college. You won't owe state taxes, either, if you choose a plan that's offered through your state. And the money you save can be used for qualified educational expenses at any college anywhere.
If you join a 529 plan, we suggest you choose the age-based investment option that most of them offer, which is based on the number of years a child has before college. For young kids, say age 6 or younger, the money goes into slightly riskier investments that pay higher returns. As a child ages, the money is moved to progressively more conservative investments. The Best and worst 529 plans shows our picks for the best and worst 529 plans, based on their 2008 rules and performance. But such things change, so check www.savingforcollege.com or www.collegesavings.org for the latest plan details.
Seventeen states offer a variant of the 529 called a prepaid tuition plan. Those have the extra benefit that you can buy all or part of the future cost of an education at today's prices, provided your child eventually attends a state-supported school in your state. If your child decides not to go to State U., you might still be able to use your savings to pay the cost, but you might not get full value. So check the rules carefully. There's a list of such plans at www.finaid.org.
The main disadvantage of 529 plans is that your money is essentially locked up. Should you need it for something else, such as a child's health-care costs, you might have to pay penalties and taxes on the withdrawal. An alternative is to save money under the child's name using a Uniform Transfer to Minors Act (UTMA) account. It's a trust that offers some tax advantages compared with saving money in your own name. But the rules are tricky, so we suggest you consult a finance or tax pro for help.