NEW YORK (Money Magazine) - This summer, investors in New York State's 529 college savings plan were startled to learn that dramatic changes are on the way. Come November, the $1.8 billion plan expects to replace longtime money manager TIAA-CREF with a trio consisting of Vanguard, Fleet Bank's Columbia Management, and Upromise, which likely will administer the plan.

The changes may prove worthwhile for some investors: While TIAA-CREF offers low-cost choices, Vanguard will likely have a larger menu of even cheaper funds.

Columbia, however, is expected to make a push for its broker-sold funds, which carry higher expenses and sales charges.

In short, it's business as usual in the financial services industry, as great investing opportunities become overshadowed by confusion, complexity, and spiraling costs.

The 529 savings plan has moved a long way from its original goal, which was to become a collegiate version of the 401(k) -- convenient, simple to understand, and reasonably priced.

Under federal rules, 529 savings plans allow anyone, at any income level, to put away money tax-free for any child for college. (That tax break is set to expire in 2010 unless Congress renews it.)

Many plans also offer state tax deductions to their residents, although you can invest in almost any state plan. Despite their federal tax exemption, however, 529s are not federally run.

Because they're an outgrowth of state prepaid-tuition plans, 529s are managed by individual states.

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And as revenue-hungry states compete for 529 assets -- more than $20 billion is stashed in these plans -- they're layering on marketing gimmicks, restrictive tax rules, and higher fees. As a result, many 529 plans are beginning to resemble high-priced insurance products rather than 401(k)s.

Make no mistake -- we still think the 529 can be a valuable option. And there are great plans still available. But there's no question that the overall appeal of 529 plans has dimmed.

We'll outline some of the problems and tell you how to cope.

Nearly every state -- 49 plus the District of Columbia -- now offers a 529. Some even have multiple versions (Nevada markets six). All told, there are more than 70 separate 529 plans in the United States, each with its own investments, rules and pricing.

Most folks simply lack the time and expertise to sort through those choices. "The complexity can be overwhelming," said analyst Luis Fleites, of financial services researcher Cerulli Associates, who has studied the 529 market. "For fear of making the wrong choice, many investors are not choosing any plan."

To keep 529 assets in their own backyards, a few states have begun to penalize residents who invest in out-of-state plans.

Last year, Illinois passed a law to limit its state tax exemption to its own plan.

And New York made a rule change that treats rollovers from its plan to other 529s as nonqualified withdrawals, which enables the state to tax the earnings and recapture prior deductions. Those taxes will be particularly painful for investors who aren't happy with New York's upcoming manager switch and might seek to move their money.

Said Bruce Harrington, 529 plan director at MFS: "These tax penalties are hurting and confusing families; 529 plans should not become a political football."

As the competition for 529 dollars intensifies, states have been turning to brokers to peddle their plans, which, in turn, is driving up investor expenses.

Indeed, broker-sold plans now account for nearly 70 percent of the money being invested in 529s around the country, according to Financial Research Corp.

Sales loads have jumped from a typical 3 percent to 5.75 percent, and lofty expense ratios are increasingly common. The funds in Wyoming's broker-sold 529 plan carry total expense ratios ranging from 1.8 percent to 2.4 percent; by contrast, the expense ratio for Utah's direct-sold plan, featuring low-cost Vanguard funds, ranges from 0 percent (money-market option) to 0.44 percent (an age-based option).

The states themselves generally charge fees -- either an asset-based fee (about 0.10 percent to 0.20 percent), a fixed account fee, or a direct reimbursement by the money manager -- which is also built into the fund's expense ratio.

The average 529 plan generates $1 million in state fees for every billion dollars invested, according to Cerulli Associates.

That money is used to cover operating and marketing costs, as well as to fund education-related programs. During the past two years, for example, Rhode Island's plan -- the largest 529, with $3.5 billion in assets -- earned more than $4 million in fees from out-of-state investors alone, which was used to finance scholarships and grants for its residents. Great for Rhode Islanders. Not so great for out-of-towners.

Add them all up, and the fees on some 529s can easily wipe out the benefit of the savings plan's tax deferral.

Clearly, these problems can be traced to the fact that the states run 529s. Most states cannot benefit from nationwide economies of scale that would lower investor costs -- and by creating multiple plans, some states make the problem worse.

This lack of cost-efficiency also prevents many money managers from turning a profit in the 529 market. Some foresee a shake-out, with fund firms exiting the market, leading to more plan upheavals. Others say it's just growing pains.

"Eventually," predicted Rhode Island state treasurer Paul Tavares, "demand and competition will lead to lower prices and better products."

Perhaps.

But a more comprehensive solution would be to scrap the state-by-state mess and create a federal 529 plan along the lines of the lifetime savings account that President Bush proposed earlier this year. His idea, however, received little support in Congress.

So what should a college saver do?

First, don't panic if your 529 switches managers. Odds are you'll have time to evaluate your new choices. New York State participants, for example, will be able to keep their existing accounts at TIAA-CREF for several years, although new money will be directed to a new plan manager in November.

Know too that you can move any 529 account between state plans once a year, though you may face a fee and extra state taxes.

It's also crucial to limit expenses. As a benchmark, think twice about a stock fund with an expense ratio of more than 1 percent.

We suggest three top low-cost 529 plans (from Iowa, Nevada and Utah) suitable for national shoppers; you can also easily find comprehensive data on all of the states' 529 plans here and at savingforcollege.com.

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Finally, avoid putting all your college savings into a 529. Too much can change, including your financial circumstances. These plans are best for high-tax-bracket families who have plenty of time to benefit from the tax break and aren't counting on financial aid.

Right now, 529s are favorably treated as parental assets in the aid formulas, but that could change with new rules next year. Also, there's no guarantee that Congress will extend the 529 tax break after 2010; if it's not renewed, earnings will be taxed at the student's rate.

Remember, there are alternatives to 529s, such as a Coverdell Educational Savings Account or simply holding tax-efficient investments in a taxable account. Why not hedge your bets and use all three if you can?