With the college loan market growing ever tighter, families need to prepare for picking up a bigger piece of the education tab. Investing in 529 plans is one part of the mix.

Every state and the District of Columbia offer at least one 529 College Savings Plan and many states offer several choices. So how do you choose the right fund?

Morningstar, an independent provider of investment information, says investors should consider diversification, management, fees, flexibility, and the mutual funds offered through a 529 Plan.

“We like to see plans that aren’t heavily reliant on any one area of the market because that can mean a more volatile ride and lower returns than what investors face at better-diversified 529 Plans,” Morningstar says in its latest fund rankings report. “Costs are key because they come directly out of investors’ returns, meaning the higher the price tag, the lower the returns.”

A 529 Plan enables parents to invest after-tax dollars in an account that typically allows investors to select from a range of mutual funds. Earnings and distributions are tax free as long as they’re used for higher education expenses.

There are two types of 529 Plans: prepaid tuition programs that allow parents to prepay a student’s future tuition at a specific school with today’s dollars, and college savings plans that allow individuals to contribute to an account set up to pay for a student’s qualified expenses at an eligible educational institution. About 300 private schools offer a prepaid program, known as the Independent 529 Plan.

Cost is the best predictor of a mutual fund’s long-term performance. When ranking individual mutual funds, Morningstar looks at the experience of the fund managers and investment strategies.

Investing in your state’s 529 Plan is likely to come with a tax deduction, but Morningstar says tax breaks aren’t enough to overcome a poorly designed or badly run plan.

Morningstar’s top-rated 529 College-Savings Plans:

Illinois Bright Start College Savings Program – The once so-so fund now offers a choice between index funds and actively managed funds. The choice of funds offered by Vanguard and Oppenheimer Holdings (OPY) come with low expenses.

Maryland College Investment Plan – The fund offers top-notch funds, including T. Rowe Price Group’s (TROW) Spectrum Income. Morningstar says the plan offers a “sensible split between value and growth strategies and also includes plenty of mid- and small-cap exposure.” Cost is low.

Virginia Education Savings Trust; Virginia CollegeAmerica 529 Savings Plan – The first offers a mix of funds run by top-notch managers and index funds in an age-based option, including Vanguard, Templeton and the American Funds. Fees are low. Virginia CollegeAmerica offers a “broad assortment of excellent American Fund mutual funds spanning many asset classes and strategies,” Morningstar says.

Colorado Scholars Choice College Savings Program – Morningstar says this is a top-rated fund sold through brokers. It offers a good mix of growth and value strategies. Expenses are low and the fund’s managers are first-rate.

Morningstar says the worst 529 Plans are Ohio Putnam CollegeAdvantage, Mississippi Affordable College Savings Program, New York 529 College Savings Program and Nebraska AIM College Savings Plan.

The funds were poorly rated for a range of reasons, including poor performance, high fees, high turnover among the money managers and lack of diversification.

Some previously top-rated funds aren’t on this year’s list, but Morningstar says it stands by its prior selections.

“If you’ve made a selection from a previous best list, you’re still in great hands,” Morningstar says.

Contributions to 529 Plans boomed last year after Congress in 2006 made the tax benefits permanent. Before Congress acted, the tax advantages had been scheduled to expire in 2010. Investments in 529 Plans now total about $112 billion.

Since 1980, the cost of higher education has outpaced the Consumer Price Index. Federal financial aid has shifted toward loans and away from grants, underscoring the need for parents to invest because they’ll pay a larger share of the bill.

In 2003, a survey conducted by the Investment Company Institute, a trade group based in Washington, D.C., found that nearly two-thirds of parents with kids aged 18 or younger were saving for their children’s college education. The survey found that the decision to save is influenced by the level of parents’ education, their age and the number of children they’re raising.