Allyson Atkins may be just 5 months old, but she's already participating in the hottest trend in college finance -- a 529 savings plan.
Allyson's father, Newport Beach investment manager Michael Atkins, started a 529 for her shortly after she was born, joining a trend that has seen these state-sponsored college savings plans grow nearly a hundredfold in the last five years. They are expected to quadruple again before 2006, according to Cerulli Associates, a Boston-based consulting firm.
The reason for their popularity: tax breaks.
From the standpoint of federal taxes, 529 plans, which are named after the section in the tax code that created them, work much like a Roth IRA. Money contributed doesn't provide a federal tax deduction, but investment earnings grow on a tax-deferred basis. And as long as the money is used for college, withdrawals from the plan are free of federal income tax.
Most states provide identical tax breaks on state income taxes for 529 withdrawals, but 23 states go a step further and give upfront tax deductions too -- offering a break on state income taxes similar to that supplied by 401(k) plan contributions.
Other pluses: The college plans give parents more control over the kids' college money, and they offer simple investment choices and modest investment minimums to accommodate parents who can't afford to contribute large amounts to the plan.
For Atkins, the fact that parents can save substantial amounts on a tax-deferred basis is particularly attractive.
"I wanted to get as early a start as possible because of the time value of money," he said. "We are very concerned about the high cost of college education."
But deciding among the wide range of 529 offerings can be daunting, said Luis Fleites, a Cerulli analyst.
"The various states have different tax laws governing them. There are different investment options, different managers, different fees and different structures," he said. "It is extremely confusing."
The plans have been around since 1997 but took off only last year, when the federal government decided to make the plans tax-free as long as the money is used for school. Withdrawals used for other purposes are subject to taxes and tax penalties, however.
The investment options in a 529 work somewhat like those of a 401(k). The plan sponsor -- an investment management company hired by the state -- picks one or several investment options from which participants may choose. Participants generally can alter their investment choices once a year.
Every state offers at least one 529 plan. Each has different investment options, fees, investment minimums and other features. Savers can choose a plan from any state, regardless of where they live. For a full-time student, the money in the account can be used to pay for tuition, fees, books or room and board at any accredited college in the country.
Unless your state provides tax deductions for contributing to your own state's plan, there's no compelling reason to favor one plan over another.
Atkins chose Allyson's plan -- the Golden State Scholarshare Fund -- on the advice of a financial commentator, who said the California program is one of the best in the country.
Experts suggest that parents consider these factors when choosing a 529:
* State tax breaks. If yours is one of the 23 states that offer an upfront deduction for state income taxes, that alone could tip the balance in favor of your state's plan.
But note: Only residents of the states that offer the deduction -- California isn't one of them -- are eligible for the tax break. For example, a Californian who decided to use a 529 plan offered by New York or Colorado would be unable to use the upfront tax deduction they offer.
* Fees. The plans carry various fees, including charges for enrollment and annual maintenance and sales charges on investments. Fees reduce returns, and all other things being equal, the lower the fees the better.
* Investment choices. Typically, 529 plans offer an age-based investment option that mixes stocks, bonds and cash in proportions the managers deem appropriate based on the amount of time the child has before enrolling in college.
Commonly, plans also offer all-fixed-income and all-stock options. Some states have plans that pay returns based on inflation of college costs.
California and a few other states offer social investment options, which screen out the stocks of tobacco producers, distillers, gaming companies and the like.
* Investment minimums. Most plans have minimum requirements for both initial investments and later contributions. But many 529 programs keep these investment minimums low -- $20 to $25 a month -- to accommodate middle- and lower-income families.
Some plans allow irregular small investments, which can be handy for those who think the child's grandparents or other relatives might want to kick into the plan in lieu of holiday or birthday gifts.
Two Web sites provide links and information about the various state plans. Joseph Hurley, a New York certified public accountant who has written three books on 529 plans, runs a site at www.savingforcollege.com, and a coalition of state treasurers has a site at www.collegesavings.org.
To contact Times staff writer Kathy M. Kristof, write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail firstname.lastname@example.org.