How to Invest for College

Knowledge and college are expensive! In 2007-08, the average senior graduated college with more than $23,000 in loans to repay. Tuition and fees only continue to go up, while the stock market, unfortunately, does not go up quite as predictably. But it is still possible to accumulate enough money to plan for a college education. Here are some tips for the best ways to create a college fund.

In the near future

First, it pays to start early. If you're only a few years away from paying for college, the stock market may be too risky a place to put your money. You'll want to look at more stable investment vehicles, such as Treasury bonds, savings accounts, money-market accounts, or Certificates of Deposit (CDs). You can look at various sites to compare interest rates on different accounts, or buy bonds through TreasuryDirect.

529 plans

If you've got a longer time horizon, your options increase. The most heavily-touted college investment plan in recent years has been the 529 plan, which allows families to put money towards a child's college education while gaining certain tax benefits. Every state now offers a 529 plan, most of them promising additional tax breaks to in-state residents who plan to send their children to in-state colleges. However, you're not geographically limited when choosing a 529 plan: you can live in Ohio and pay into Florida's plan, or vice versa. Financial-services firms such as Vanguard and Fidelity also offer 529 plans to investors.

Once you put money into a 529 plan, you can choose how to invest it. Frequently, you will have a choice among various investment plans. Some plans are static in the way they allocate your money, meaning that every time you put $100 into the fund, $60 will go towards stocks and $40 will go towards bonds or other investments. Others vary by age, investing heavily in stocks when your child is younger and shifting towards more conservative investments as college gets closer.

The Web site Saving for College allows you to compare different 529 plans and find out more information about how you can invest your money within a particular plan. Morningstar, an investment research firm, also presents a guide to 529 plans and ranks the best and worst performers every year.

ESA plans

You can also establish a Coverdell Educational Savings Account (ESA). Like a 529 plan, a Coverdell ESA gives tax breaks to people who store money away, this time at the federal level. Be aware, however, that provisions covering the Coverdell ESA are set to expire in 2012; if they're not renewed, annual contribution limits will go down from $2,000 to $500, and withdrawals will no longer be tax-free under certain circumstances.

Roth IRA

Another way to save money for college is through a Roth IRA (Individual Retirement Account), which allows money to be withdrawn tax-free for college. The main advantage of a Roth IRA is that money saved there, unlike in a 529 plan or Coverdell ESA, can't be counted by colleges as savings when they're determining your financial-aid package. The main disadvantage is that a Roth has a maximum contribution level (if you're under age 50, $5,000 in 2011), and any money you save via a Roth IRA for college is money not earmarked for retirement.

In short, the closer you are to paying for college, the more conservatively you'll want to invest. Even if college is a decade or more off, you want to do careful research and make sure you understand how your money is being invested to get the greatest benefit for your college resource fund.