College Savings

Next to retirement, higher education is a top priority for many investors. And while it may well be one of the biggest financial obligations of a lifetime, it is also money well spent when you consider the doors it can unlock for you or your children. According to the College Board, even students who borrow a sizable share of the funds required to pay for college are likely to be financially better off relatively soon after graduation than they would be if they began their full-time work lives immediately after high school.

There are several options available for paying those college tuition bills, including federal grants and scholarships, financial aid, student loans and education savings and investing plans. Not all students qualify for scholarships, which are primarily based on merit, nor for financial aid, which is based on financial need. Student loans can be a viable option, but leave you and/or your child saddled with debt that can be as large as a mortgage. A better plan, or a supplement to any of the aforementioned funding strategies, is an education savings and investing plan. Investors have a number of options to "fit the bill."

529 College Savings Plan

Perhaps the most popular education savings and investing vehicle is the 529 College Savings Plan, which was authorized by Congress in 1996 to encourage Americans to save for higher-education expenses. Through this tax-advantaged plan, a parent or other account holder can establish a fund on behalf of a student to cover qualified education expenses. Earnings on and withdrawals from a 529 account are exempt from federal, and sometimes state, income tax as long as the money is used for eligible college expenses. (Withdrawals not used for eligible college expenses may be subject to income tax and an additional federal penalty tax.)

529 plans are administered by individual states and, therefore, the details of each can vary. But in all cases, 529 plans offer professionally managed investment solutions rather than being self-directed. Most offer age-based or risk-based asset allocation options. In an age-based plan, the underlying investments become more conservative as the beneficiary approaches college age. A risk-based plan maintains the same mix of stocks and bonds regardless of the beneficiary's age, based on the model (these generally range from conservative to aggressive) selected by the account holder.

Coverdell Education Savings Account (ESA)

The Coverdell ESA is a custodial account originally introduced as an "Education IRA." Coverdell ESAs allow money to grow taxdeferred and proceeds to be withdrawn tax-free for qualified education expenses at qualified institutions. Notably, this currently can include primary and secondary schools, a unique feature not available in a 529 plan. The guidelines for ESA investments are generally consistent with those for an IRA. Balances in a Coverdell ESA must be used for qualified education expenses by the time the beneficiary is 30 years old; alternatively, they may be gifted to another family member younger than age 30 or rolled into a 529 plan in order to avoid taxes and penalties.