The Economic Growth and Tax Relief Reconciliation Act of 2001 (Tax Act) significantly expanded the tax advantages of qualified tuition programs, also called Section 529 plans. Starting in 2002, the key new features include:

• The money in the plan can be withdrawn tax-free (including the investment earnings), as long as they are used to pay qualified educational expenses.
• Public and private colleges can now sponsor prepaid tuition programs. Formerly, only states could sponsor these programs.
• You can now claim the HOPE Scholarship Credit or Lifetime Learning credit in the same year tax-free distributions are taken from a Section 529 plan, as long as the credit is not claimed for amounts paid with the tax-free distributions.
• Instead of a plan-imposed penalty on withdrawals not used for qualified higher-education expenses, a 10% federal income tax penalty will be imposed.
• Once every 12 months, you can make a tax-free transfer of funds from one plan to another for the same beneficiary. In the past, you had to change the beneficiary to make a tax-free transfer.
• The definition of family member has been expanded to include first cousins.

Other provisions that remain the same include:

• You are the account's owner and can change the beneficiary or even take the money back (if permitted by the plan). If you decide to take the money back, you will owe ordinary income taxes on earnings and the 10% federal income tax penalty.
• The money can be withdrawn without penalty if the beneficiary dies, becomes disabled, or receives a scholarship.
• You can contribute up to $55,000 in 2005 to a qualified tuition program ($110,000 if you and your spouse make a gift) in one year and count it as your annual $12,000 tax-free gift for five years. However, if you die within the five-year period, a pro-rata share of the $60,000 returns to your estate.
• No income limits exist for making contributions to these plans.
• Most plans allow you to contribute even if you don't live in the state that sponsors the plan.
• For financial aid purposes, these plans are typically considered assets of the parents. However, even though withdrawals are tax-free, they will probably be considered as the child's income.
• The main drawback of Section 529 plans is a lack of investment flexibility since the sponsoring state selects the investment manager and options. Costs also can be a concern since there are administrative expenses in addition to the normal mutual fund charges. Even so, a number of low-cost plans exist.

Qualified tuition programs come in two forms:

• With prepaid tuition programs, you pay a fixed amount now for a guarantee that sufficient funds will be available to cover tuition. Many states offer these plans and this is the only option private colleges can offer.
• With college savings plans, you place money in a plan to be used for the beneficiary's higher-education expenses at any college. Your money is invested in stocks, bonds, or mutual fund options offered by the plan, with no guarantee as to how much will be available when the beneficiary enters college.

Like other provisions of the Tax Act, provisions regarding Section 529 plans are scheduled to expire in 2011 unless further congressional action is taken.