I f you have a collegebound child or grandchild, consider “529 plans.” Named after a section of the Tax Code, they are loaded with tax benefits and have already attracted billions of dollars, according to some estimates. They can be excellent vehicles for college funding.

HOW THEY WORK

These plans allow parents or grandparents to shift income to the child’s lower tax bracket without losing control of the assets generating that income.

Under Section 529, states can set up plans that qualify for tax breaks. These tax benefits are available to everyone, regardless of income...

Any income earned inside the plan is not currently taxable.

When money is withdrawn from the plan to pay higher-education expenses, taxable income is triggered. The taxable amount is the difference between the total withdrawal and the total contribution to the plan. Income is generally taxed to the low-bracket beneficiary.

The money saved in 529 plan accounts can be used to pay for tuition, books, fees and certain room-and-board charges.

Undergraduate and graduate school costs are eligible.

Beware: You can’t use 529 money for precollege education expenses. And these plans could affect students’ financial-aid eligibility.

CONTROL OF MONEY

With 529 plans, parents won’t lose control of money meant to be used for college. There’s no risk that your child will use the cash to buy a car or take an extended vacation.

There is an alternative way to shift income to your children. Transfer assets to a custodial account.

But assets in custodial accounts will belong to the child when he/she comes of age, as early as age 18. And money put into a custodial account will usually mean taxable income each year for the child.

ADDED BENEFITS

If you need emergency cash, you can withdraw it from a 529 plan. You’ll be taxed on the distribution and will pay a penalty, however.

If the money in a 529 plan isn’t needed for college due to death, disability or a scholarship, penalty-free withdrawals are permitted.

Roll over the account balance from one student to another family member’s account, tax- and penalty-free. Rollovers also may be made to a beneficiary’s spouse as a family member attending college.

A 529 plan does not throw off taxable income until the year in which withdrawals are taken. This can be a huge relief around April 15 of each year until then.

Important: Each distribution is deemed partially taxable -- and partially tax-free, depending on the current ratio of earnings to contributions. The IRS requires the program’s investment director to send out form 1099G annually, indicating the taxable portion of withdrawals.

PAYING ATTENTION

In recent years, 529 plans have proliferated...

Forty-nine states have 529 plans in operation or under development.

Exception: Georgia. (For current status, see www.savingforcollege.com.)

Old-style “prepaid tuition plans” are still offered by about a dozen states. In these plans, investment returns are guaranteed to keep pace with increases in college tuition. Such plans may have restrictions on who can invest and at which schools the proceeds may be used.

New plans, which are actually managed investment funds, are becoming the norm. Some plans have guarantees, and there is the potential for returns higher than the rate of tuition growth (which has slowed in the past decade).

Key: New plans are more flexible than prepaid tuition plans. Most are open to anyone (not just to in-state residents) and the money can be used at virtually any accredited school in the US for approved expenses related to higher education.

New 529 plans have more upside than prepaid tuition plans as well. Investors will enjoy any growth of the underlying securities. Proven money-management firms, such as Fidelity, Merrill Lynch, Putnam and Salomon Smith Barney, make the investment decisions.

In 11 states, 529 plans are run by TIAA-CREF, which manages billions of pension dollars for education and research employees. Its Web site, www.tiaa-cref.org/tuition, has a calculator to help you determine how much to invest for your children’s college education.

New 529 plans follow preset asset-allocation guidelines, with stocks giving way to bonds as the child nears college.

Downside: With these plans, you have no say in how college funds are invested. But you may now be able to choose the investment program -- for example, opting for all fixed income.

Section 529 plans work particularly well for younger children, who will have many years to benefit from tax deferral. Look for 529 plans that invest heavily in stocks, which likely will post hefty long-term returns.

Caution: The plans can lose money if equity investments decline in value.

MAKING CHOICES

Check restrictions. Some plans have a three-year waiting period until contributions can be used for college, so they don’t make sense for older teens. Other plans have only a 12-month waiting period.

Permitted use of funds. Most plans state that the money can be used to pay for books, supplies or off-campus housing. Other plans include all books and supplies as well as apartment rentals for students who attend college at least half-time.

Investigate the investment approach. You may want a plan in which the initial equity allocation for a young child’s account is 80% invested in stocks rather than a plan in which only 60% is. Long-term, stocks are likely to pay off.

Playing the odds: Some plans allow investors to choose a 100% equity option, which likely will yield the highest returns over 10 years or longer.

Focus on fees. Some plans charge much higher investment management fees than others. Look for programs with a management fee of 1% or less. Over time, this can make a huge difference in the amount accumulated.

Do your homework. Many states offer some form of state tax benefit on top of the federal tax breaks...

In-state investors may get a deduction or credit against state income tax.

Plan earnings may be exempt from state income tax when used for college.

Find out if the value of these tax benefits outweighs any of the plan’s disadvantages.

FROM GOOD TO EXCELLENT

Federal tax legislation to make Section 529 earnings tax-exempt rather than tax-deferred has passed Congress twice. But -- it was vetoed as part of larger tax bills. Both political parties have expressed support for tax-free 529 plans.

Should the earnings from 529 plans become tax-exempt, that would apply to money already invested there.

Such an expanded tax benefit would make a sweet deal even more appealing.