If imitation is the sincerest form of flattery, American Funds has a lot to be proud of. An innovative 529 plan it launched with the State of Virginia last Friday has caused at least two other investment managers to revamp their own college savings plans, according to industry executives.

American Funds' plan, called CollegeAmerica, was the first to announce that it would offer individual funds in its program. Until recently, 529 plans offered only pre-designed portfolios of mutual funds.

But in a case that highlights the intense competition in the 529 college savings market, American Funds was beaten to the market by other firms offering similarly designed products. Those firms moved quickly to implement similar product designs before American Funds' plan was unveiled.

Last Tuesday, Alliance Capital began offering nine individual funds in addition to the five predetermined allocations in the CollegeBoundfund, the firm's 529 offered through the State of Rhode Island.

And in January, Putnam Investments added 10 individual funds (it calls them "individual asset classes") to the four asset allocation portfolios it already offered in its 529 plan with Ohio.

But even though Alliance and Putnam managed to launch product before American, American is the true innovator, sparking a trend in the 529 market, according to Chris Stack, a managing consultant for Saving For College Service, an affiliate of SavingForCollege.com. "Alliance and Putnam have already followed suit. I think more investment managers will add what you could call an a la carte' menu of individual funds to their 529s."

Last April, American Funds began talks with Virginia to create its unique plan. Up until then, it was thought that the IRS would not approve of such plans. The law required funds to offer portfolios made up of several different funds in order to provide a sufficient level of diversification.

"The law reads that you cannot have a concentrated portfolio, that it has to be diversified," said Chuck Freadhoff, a spokesman for American Funds. "Something like the Bond Fund of America, which holds a spectrum of bonds, is itself diversified though."

American Funds sought approval from the IRS, making the case that mutual funds are sufficiently diversified and that 529 plans should be allowed to offer them individually, according to Freadhoff. The IRS agreed and American Funds announced its plan at the end of July.

Once American Funds announced it would begin offering individual funds in its 529 plan, Alliance and Putnam followed its lead and sought similar IRS approval, Stack said.

"The IRS' interpretation, which we heard of at the end of the summer, was that mutual funds are adequately diversified investment portfolios created to meet the requirements of the internal revenue code," said Richard Davies, executive VP of Alliance Fund Distributors. "The conventional wisdom prior to that was that you had to offer portfolios of multiple funds."

According to Davies, several fund companies were informally asking the IRS for an interpretation of the 529 code and whether individual funds could be offered.

"There's still a lot of gray area in 529s," Davies said. "The IRS hasn't issued final rules on 529 plans yet."

However, last year's Economic Growth and Tax Relief Reconciliation Act offered further clarification of what investment managers could offer in 529 plans, said Elaine Sullivan, Putnam's director of college savings plans. The Act changed the 529 code to allow investors to modify their investments annually, which lets them opt into one or more funds without being trapped, Stack said.

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