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Why You Need These 3 College Savings Strategies Now

The rising cost of college graces headlines often and hits parents' pocketbooks even more frequently. Mounting piles of student loan debt not only speak volumes about the unaffordability of college, but also the unavailability of a family piggy bank for higher education. Families could use a break.

Let's first address the costs of higher education, then I'll provide three strategies to help with some of the heavy lifting.

The price of higher education
"In the coming decade, 60% of new jobs will require more than a high school diploma," President Obama recently said. "Higher education is not a luxury. It's an economic imperative that every family in America should be able to afford." But, in reality, many families can't afford college, so students are graduating with record levels of student loan debt.

Over time, college costs have been rising at twice the rate of inflation and show few signs of slowing. Parents of a newborn need to diligently save more than $300 every month for 18 years -- in an investment returning 8% no less -- to pay for college. Even more shocking, this assumes a modestly priced college with a current $15,000 annual price tag.

Solutions for those still trembling from sticker shock
The only way to outpace the cost of college is by investing in stocks, exchange-traded funds, or mutual funds. Consider the following three strategies to help you save for your child's college education.

Custodial account
Money in a custodial account can be invested in many different securities, including CDs, stocks, bonds, and mutual funds, and the assets don't have to be used exclusively for college. But once you've transferred money into a custodial account, you're not permitted to take it back. When your child turns 21 years old (or a younger age, in some states), the account becomes an asset of the child. Never transfer money to a custodial account unless you are 100% sure you won't need that money later.

You can open a custodial account at just about any financial institution, including banks, credit unions, mutual fund companies, and brokerage firms. There's typically little or no fee to open an account, but fees or commissions are assessed when purchasing securities in the account.

Coverdell education savings account
Originally known as education IRAs, Coverdell accounts provide significant tax benefits. Even though you don't get a tax break when you contribute, earnings in the account are not taxed and may be entirely tax-free. Distributions from the account can fund education expenses from kindergarten through college.

However, tax-advantaged withdrawals on K-12 expenses and other favorable Coverdell provisions will disappear after Dec. 31 unless extended by Congress. Currently, you can only contribute $2,000 annually per beneficiary in a Coverdell, but this annual limit will drop to $500 after year-end. If you own a Coverdell account, make sure you are aware of these upcoming changes, although you can roll over a Coverdell into a 529 college savings plan in the future if the changes outweigh the benefits.

Shopping different brokers can give you a variety of choices for a Coverdell investment. For instance, Charles Schwab (NYSE: SCHW  ) is just one of many brokers that does not charge a fee to open or maintain a Coverdell. Like many of its peers, Schwab offers inexpensive online stock trades and free Schwab ETF online trades, and all it takes to open an account is a commitment to set up monthly transfers of $100 or more. Similarly, Capital One (NYSE: COF  ) offers Coverdell accounts through ShareBuilder where you can invest in stocks, ETFs, and mutual funds at low cost with no account minimum.  

529 college savings plan
Long considered the prettier sister to the less desirable Coverdell, the 529 plan boasts much higher contribution limits than Coverdell accounts. The 529 plan allows individuals to save and invest on a tax-advantaged basis to fund future college expenses. You don't pay federal or state taxes on 529 plan withdrawals as long as the money is used for qualified, higher education expenses including trade school, vocational school, junior college, and universities.

Investing in your state's sponsored plan may offer another layer of tax benefits, as many states offer tax deductions up to a certain amount on contributions to their state-sponsored 529 plans. For example, the West Virginia 529 plan offers West Virginia taxpayers state income tax deductions in the amount of their contributions. Hartford Financial (NYSE: HIG  ) manages the program, which mostly offers loaded mutual funds, but no-load funds are available to residents of West Virginia. While state-sponsored plans are a great way to go, you can generally enroll in any 529 plan regardless of where you live. You can find out about 529 plans offered in your state here.

Franklin Resources (NYSE: BEN  ) offers a 529 plan filled mostly with its own professionally managed mutual funds. Franklin's 529 plan charges a $25 annual account maintenance fee and assesses various sales charges for particular classes of the plan's loaded mutual funds. You can open a Franklin 529 plan with as little as $50 if you commit to a monthly automatic investment program.

Save early, save often, and start today
Don't let the rising cost of college frustrate you. The worst college savings plan is the absence of one. Take action to secure your kiddo's future, and consider these three solutions today.

If you'd like a sensational stock idea for your kid's college savings plan, our analysts have found one for you. Read about the one stock they feel so strongly about they've dubbed it "The Motley Fool's Top Stock for 2010." This report won't be available forever, so get your free copy today.

Fool contributor Nicole Seghetti doesn't own shares of the companies mentioned. Motley Fool newsletter services have recommended buying shares of Charles Schwab. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (5) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 04, 2012, at 2:30 PM, DirtyTomRackham wrote:

    With a recent newborn I just started working on saving money and trying to figure out where to invest it. At this point I haven’t gone beyond setting aside money each week in a savings account (given the return on stocks the past month this puts me ahead!).

    What I’ve found is that these 529 plans sound great (tax free!) but when you factor in the fees charged annually on the account, the benefit you get from the tax savings is lost to the fees. The amount of fees racked up over 18 years compared to the growth you’ll get on that investment I found worked out to effectively be a tax of about 15% (I assumed a 0.5% annual fee factor). Plus, it seems you’re limited to fairly conservative investments.

    I don’t see why investing money myself (like putting money in an index fund annually), and paying the capital gains when the money is withdrawn isn’t a much better plan. I suppose that’s the same as a custodial account, except I’m in control of the funds.

    Are there no taxes on the gains on a custodial account to make that advantageous? Or taxed at the child’s rate? Said another way, why is a custodial account an advantage over simply investing the money in my own name and having the option to give it to my child for college costs when they come up?

  • Report this Comment On June 04, 2012, at 2:53 PM, iamlard wrote:

    Congrats on the birth of your newborn, Tom. I'm not far behind you (4 more weeks to go).

    In addition to the high fees on most of the 529 plans, the lack of investment options is appalling. I did a quick scan of all 50 states' 529 plans, and none looked particularly appealing to me.

    With the limits on Coverdell contributions dropping to a pathetically low value, and the poor choices in 529 plans, a custodial account is sounding better and better.

  • Report this Comment On June 04, 2012, at 6:46 PM, Mikovich wrote:

    The ten year cost of $10,000 invested in New York's 529 is $318. That's pretty reasonable.

  • Report this Comment On June 05, 2012, at 9:26 AM, npush318 wrote:

    Nicole...what are you smoking? How would 8% at 18 years on $300 monthly deposits be needed to pay for a $15k/year college? That would amount to nearly $150,000. $15k/year runs you about $60k + fees/room&board I'm only seeing the need for about $100k assuming they will pay for none of it.

  • Report this Comment On June 06, 2012, at 9:11 AM, seghetti wrote:

    smashwebs,

    Check out the following calculator for more info:

    https://www.edwardjones.com/en_US/resources/calculators/coll...

    Nicole

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Nicole Seghetti
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Nicole is a contributing writer for The Motley Fool. She's worked as a financial advisor and planner for over a decade. Nicole holds an MBA from the University of the Pacific and a chemical engineering degree from Purdue University. She welcomes you to follow her on Twitter.

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