Last Updated: June 8, 2009 

If you're saving for college using a Section 529 plan take heed. Those plans are getting better according to Morningstar, Inc., which recently released its sixth annual study of the best and worst 529 plans.

2008 was a terrible year for 529 plan investors according to Greg Brown, a Morningstar mutual fund analyst and author of the study. However, "the industry has made strides by lowering fees, improving investment options, and closing down poorly structured plans," Brown said in a release.

In its study, Morningstar focused on the underlying funds, expenses, diversification, asset allocation, and flexibility. The firm evaluated the quality of the underlying investments by looking for funds with experienced managers, a history of good stewardship, and sensible strategies, among other factors.

To be fair, it would be easy to simply select a 529 plan based on the results of a study such as Morningstar's. However, financial planners say it's important to look at an array of factors before selecting a 529 plan or deciding to move your existing 529 plan to another.

A 529 plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code which created these types of savings plans in 1996, according to SavingForCollege.com. There are two main types of 529 plans and at least seven big benefits to 529 plans, including the fact that money in such accounts grows tax-free and distributions to pay for the beneficiary's college costs come out federally tax-free.

"When searching for and selecting a 529 plan," FPA member, Leslie Beck, CFP®, said "you should focus on three things:

1. The availability of state tax (or other) incentives to use a home-state plan.
2. The choice of funds available in the plan; the more, the better.
3. Fees charged, including annual fees charged by the state, and fees charged by the mutual funds in the plan."

In some cases, she said she might recommend a combination of plans. For example, she said New York state's direct plan offers great tax incentives for New York state residents, up to $10,000 for married couples annually, but not a great selection of funds.  "So, we may advise a New York state resident to open a New York Direct 529 plan, invest up to $10,000 per year to take advantage of the tax benefits, but invest the remainder of the annual gift exclusion (for 2009 $13,000 per spouse per child, or a total of $26,000 per child) in a plan with better fund choices, such as Virginia's CollegeAmerica plan," she said.

In other cases, New Jersey, for instance, offers no state income tax breaks at all for staying with the in-state plan (there's a small tuition credit that can only be used for in-state schools), nor are there great choices within the funds, she said.  "So we recommend that New Jersey residents go with the Virginia plan as well, which has great fund selection and relatively low fees."

Meanwhile, other financial planners share Morningstar's and Beck's point of view about the importance of low fees. "We evaluate plans based on manager selection, allocation and fees," said FPA member, Elaine King, CFP®, vice president at Gibraltar Private Bank & Trust. "We tend to avoid heavy fees and manager turnover."

Morningstar's rankings of the best and worst 529 college savings plans.