Nov. 22 (Bloomberg) -- When parents try to save for college expenses, they often go through a financial hazing.

Not only are they saddled with confusing and expensive state savings programs, they also have to endure countless pecuniary pledge nights to plan for financial aid.

The governmental bodies that regulate college funding are of little help, while costs continue to soar. Total charges (tuition and room and board) for public universities climbed 25 percent during the last four years to an average $11,354, according to The College Board, a research and testing organization. Private university fees increased 14 percent, averaging $27,516.

Clearly, financial aid and funding programs could be improved to put more assets to work, yet both are mired in needless complexity and expense.

Take 529 college savings plans, for example, which are offered by states and provide federal and often state tax breaks if money withdrawn is used for college. States limit the competition for the $50 billion invested in these plans, which often impose some of the highest fees on the market.

The 529 Trap

Austan Goolsbee, a professor of economics at the University of Chicago's Graduate School of Business, is saving for college for his two children. To date, though, he has avoided 529 plans because of the high expenses and inflexibility.

``This really drives me nuts,'' Goolsbee said. ``529 plans were designed to offer tax breaks for college savings and ended up being lucrative subsidies for financial providers.''

Since states levy administrative fees on investors' assets placed in their plans, they have a huge monetary incentive to market their own 529s. They also may favor in-state brokers and managers who lobby for the business.

It's difficult to tell which plan is the best deal, though, since there's no clear, upfront disclosure of all fees or tax benefits. Not subject to federal mutual fund or securities regulation, 529s have recently been the target of an investigation by the National Association of Securities Dealers, the federal regulator of securities dealers. The agency is reviewing broker sales practices. The College Savings Plan Network, a group of state treasurers who sponsor 529s, is promoting voluntary guidelines to improve disclosure.

States Penalize Investors

Since fund choices are limited in 529s, college savers are often stuck in programs where expenses are higher than non-529 accounts.

For example, you could pay as much as a 5.75 percent commission -- in addition to fund expenses of more than 1 percent annually, plus as much as 0.88 percent per year just in the state's administrative fee -- on 529 plans sold through brokers. In contrast, you could easily find a Coverdell Education Savings Account with no sales charge and less than 0.50 percent in annual expenses. And you would have a choice of thousands of mutual funds.

The broker-sold fund expenses not only devour returns, they negate the financial benefit of state tax breaks, where offered.

``A lot of people don't even realize they don't have to invest in their state plans,'' says Goolsbee. ``States have monopolies and marketing power. And the tax breaks disappear with the high (529 mutual fund) fees.''

Regulators Investigating

The best recent proposal for disclosing 529 plan expenses came from Republican Senator Peter Fitzgerald of Illinois. Fitzgerald, who is leaving the Senate, requested that the U.S. Treasury Department require that 529 sponsors disclose all fees, commissions and internal fund expenses in a standardized format.

``These fees on top of fees substantially erode investor returns,'' Fitzgerald stated in an Oct. 25 letter to Treasury Secretary John Snow. Fitzgerald also noted that having state governments sponsor 529s ``serves no apparent purpose.''

``There are wildly varying expense levels within 529s,'' said Mercer Bullard, a law professor at the University of Mississippi, who has testified before Congress on the subject.

``I would yank these investment products out of the hands of the states, give everyone a state tax break and let residents choose from any plan,'' Bullard says.

Another area that has parents bewildered is the financial aid arena. If you have saved money in a child's name or through a Uniform Gift to Minors account or similar vehicles, you hurt your child's chances for getting financial aid.

Aid Formula Unfair

Parental assets such as retirement accounts or home equity, though, aren't counted in federal financial aid calculations (although they may be counted by some private colleges). So the process unfairly penalizes those who have saved in their children's names and often favors those with high balances in their retirement plans or who have significant home equity.

Susan Dynarski, a professor at Harvard's Kennedy School of Government, has long been critical of the aid process.

Say you have saved $1,000 in pretax income and placed it in an account in your child's name for 18 years. Dynarski found that you would lose $1,881 through income taxes and loss of financial aid versus having the money invested in your name.

``Such arbitrary policy variations undermine the goals of need-based aid,'' Dynarski says, ``in that families with identical financial positions receive very different levels of aid, depending on whether they are savvy enough to steer their savings toward the right vehicles. It shouldn't matter what vehicle you put the money in.''

Change Aid Calculation

In an attempt to make the aid process fairer, Dynarski would like to see all parental and student assets treated uniformly in the aid formula.

``Under such a system, the aid `tax' rate on assets would be the same across savings vehicles,'' Dynarski says.

Until Congress and the states level -- and open up -- the playing field with college funding options, you are on your own and will need sophisticated financial planning to maximize your chances for aid and provide the funding you need for college.

Don't approach any commissioned sales representative for this advice, though. Try fee-only financial planners or advisers who don't sell college savings products (see http://www.napfa.org ).

In the meantime, informed investors like Goolsbee say they will invest in low-cost, out-of-state 529 plans and put as much as they can in 401(k)s and other retirement accounts, which aren't considered in most financial aid formulae.

College funding needn't be an investor-unfriendly process. It's time that state and federal lawmakers received a proper education on this subject.

To contact the writer of this column:
John F. Wasik in Chicago at  jwasik@bloomberg.net.

To contact the editor responsible for this column:
Bill Ahearn at  bahearn@bloomberg.net.