Education is a hot issue this political season, and state tuition programs, known as 529 plans, allow parents and grandparents the ability to save for childrens' education while enjoying substantial tax benefits.

Although qualified state prepaid tuition programs have been around for some time, they have not enjoyed great popularity, but that could be about to change. Financial planners, CPA's, and investment houses are increasingly discussing the benefits of new state-sponsored plans with parents and grandparents.

Under IRC Section 529, states can offer special investment plans for the purpose of meeting the expenses associated with higher education. Income generated within the plan is not currently taxable, and when withdrawals are made to meet education expenses, withdrawals are considered to be "return of investment" first, and then ordinary income. This is commonly referred to as FIFO (first in-first out) taxation. In addition, the student, who presumably is in a lower marginal income tax bracket than his/her parents or grandparents, owes any income tax liability.

An additional advantage of the 529 plan is the gift tax treatment of contributions to the account. A parent or grandparent may contribute up to $50,000 (the maximum annual contribution) per child, and elect to spread that gift over a five-year period for gift tax purposes. Since the current annual gift tax exclusion is $10,000 per person, this effectively eliminates any gift tax on the contribution. Also, amounts contributed to the account are removed from the taxable estate of the donor. Currently, 48 states either have programs in place or in development, with Georgia and South Dakota the only holdouts.

While 13 states (including Maryland), operate the old style traditional prepaid tuition program (in which parents are guaranteed that their contributions will keep pace with increases in college tuition), new 529 plans are becoming much more popular. The advantage of the old style plans is the guarantee that assets will keep pace with educational costs, but offer no potential for greater investment returns. New style plans are actually managed investment funds, which offer much more flexibility than their prepaid tuition cousins. If money is not required for college expenses because of death, disability, or a scholarship award, penalty-free withdrawals are permitted. In addition, a transfer from one student's account to another student family member is allowed, without tax or penalty. Money from the new style 529 plans can be used at virtually any accredited school in the United States, for approved higher education expenses.

The combination of tax benefits afforded the donor, coupled with investment flexibility and student transferability, is making the new 529 tuition account one of the most popular estate and financial planning techniques in the U.S. Both major political parties have indicated a willingness to further enhance the benefits of these plans. It may well turn out that 529 plans will become to education what 401(k) plans have become to retirement.