Crash course on college savings

January is a busy month for 529 college savings plans, as parents try to put the holiday checks from Great Aunt Edna to good use before the kids start begging for new toys. But like any financial product, good intentions can be stymied by complexity and confusion. If you're scratching your head over these plans, this column is for you.

What's up with the name?

It's named after Section 529 of the IRS code, which lays out the rules governing these tax-advantaged college savings plans.

I keep hearing that 529 plans are "tax-advantaged." What does that mean?

The money you invest grows tax-free. And you don't have to pay taxes when you take it out, so long as you use the money to pay for qualified education expenses such as textbooks and tuition. If you do take the money out for another purpose, you'll be socked with a 10 percent penalty plus income taxes on the earnings.

Does a 529 plan affect financial aid?

Yes, but not by much. First, a certain amount of parental assets -- including 529 plans -- are sheltered from affecting aid eligibility. That amount is dependent on the eldest parent's age, Mark Kantrowitz, founder of finaid.org, explained. After that, 529 plan assets in a dependent child or parent's name will reduce financial aid by no more than 5.64 percent of the account's value. "So if you have $10,000 in a 529 plan, worst-case scenario is it reduces your aid eligibility by $564, meaning you're still going to be left with $9,436," said Kantrowitz, whose new book "Secrets to Winning a Scholarship," comes out in February.

No. Most states sponsor at least one 529 plan, but you are not limited by the state that you live in, or where your child wants to attend school. While you can invest in New York or Utah's plan, stay close to home if you live in a state that offers a tax break for using its plan. In Minnesota, there's no income tax deduction, but there is a state matching grant program for families who make less than $80,000, although the value declines for families making $50,000 or more. For details visit: www.mnsaves.org.

My adviser wants me to open a 529 plan with him. Should I?

No. You'll typically pay lower fees if you open an account with a direct-sold 529 plan. Look for one that charges less than 1 percent. Only consider opening it through your financial adviser if you know you'll never get around to it on your own, or you really want your adviser to manage the account for you. Be sure to ask your adviser how much it will cost you. You can research 529 plans at www.savingforcollege.com or www.morningstar.com.

Who is the account holder?

Most advisers recommend opening a 529 plan in the parents' name, then naming the child as the beneficiary. If the child is the account holder, Junior takes control of the money at age 18 in Minnesota. And while it's pretty easy to transfer funds from beneficiary to beneficiary in a 529 plan, opening an account for each child sends a positive message. "529 plans are a fantastic way to reinforce the value of saving. They see a statement with their name on it," Ameriprise Financial adviser Ginger Ewing said. "I think it's a great way to acclimate a high school student to the issues of how college is going to be funded," said Bruce Ensrud, a senor financial consultant with Thrivent Financial for Lutherans.

529 plans have a variety of investment options, just like 401(k) plans. Kantrowitz suggests picking an age-based option, which gets more conservative as your child nears college age. Most plans also have options that don't invest in stocks, but as Kantrowitz points out, it's hard to keep up with tuition inflation if you're invested in certificates of deposit.

How much can I save?

More than $300,000 per beneficiary in many plans, an astronomical sum for the vast majority of us. The bigger question is how much should you save? Because 529s are designated for college costs, and you never know if your child is going to join the circus or get a full ride to an Ivy League school, Ewing recommends that her clients don't go overboard with 529 plans, saving only some of the money dedicated to college in the account.

Then there's the issue of how to prioritize college savings. Ensrud says families are often swayed by "the tyranny of the urgent" -- that paying for college, not retirement, is the top priority because freshman year is fast approaching. But as he and many others have pointed out, students can borrow for college. Good luck trying to get a loan for retirement.