The state of Illinois recently announced the launch of a second 529 college savings plan, Bright Directions. With a large selection of funds and multiple fund families to chose from, this new plan offers greater flexibility with the same tax advantages as the state's existing plan, Bright Start. But when it comes to saving for college, the best solution for your family may not always be the closest.

Named after section 529 of the Internal Revenue Code, 529 plans are designed to offer tax advantages to encourage saving for future higher education expenses. Currently, all 50 states sponsor at least one 529 plan, and they vary widely in investment options, eligibility requirements, fees, expenses and other features. Weighing the pros and cons of some key issues can help you determine where your funds should reside.

• State Tax Deduction* – While all 529 plan withdrawals are currently exempt from federal income taxes, most states also allow tax-free withdrawals of contributions and earnings. Contributions to some plans may also qualify residents for a state income tax deduction. However, the value of this benefit depends upon a number of factors. Since state taxes are a deductible item on federal tax returns, those who make large annual college savings plan contributions or are subject to high federal marginal tax rates may enjoy a reduced benefit from the state tax deduction.
• Fees and Expenses – Each 529 plan sponsor charges an annual program fee, expressed as a percentage of account balances, for costs related to administering and monitoring. These fees vary widely among plans. Depending on how long you hold the account, those differences could dramatically affect the total return on your investment. In fact, the benefit of a significantly lower fee from an out-of-state plan often may more than offset the savings from an in-state plan's tax deduction.
• Fund Performance – As 529s are intended as long-term investment vehicles, investors should look for consistent investment processes and a reasonable expectation of superior future returns. While past performance is not a guarantee of future results, looking at a fund's performance ranking against a universe of similar funds over five- and 10-year periods can provide insight about the manager's long-term potential during various investment environments.
• Management Philosophy – 529 plan assets are overseen by a money manager chosen by the state. Before you invest, you should explore the range of fund options offered in various plans and decide which manager's philosophy best corresponds with your own attitude about investing and your tolerance for risk. As with any investment, no single plan will be the best choice for every family. Your own circumstances and objectives should serve as a guide for comparing the pros and cons of the various options.

Keep in mind that 529 plan features and provisions change continuously, as do the rules governing their tax treatment at both the state and federal level. To ensure you make the most fully informed decision, you should consult with a tax professional. For more information about which college savings vehicle may be best for you, please contact your Mesirow Financial representative.

*Neither Mesirow Financial nor its employees provide tax advice.

This article originally appeared in the 2006, 1st quarter edition of the Mesirow Financial Quarterly. Click here to access the current and all past issues of the Quarterly.