Ask Dr. Don By Don Taylor, Ph.D., CFA • Bankrate.com

Investing for college

Dear Dr. Don,
What's the best way for me to save money for my 5-year-old son's college fund?
Kristin College

Dear Kristin,
There are so many good ways that it's hard to decide. The three principal choices are the Education IRA, since renamed the Coverdell Education Savings Account, a Section 529 College Savings Plan, and the Savings Bonds for Education plan.

It depends on whether you're planning to invest a lump sum upfront or starting an investment plan where you make regular contributions over time. I'd say it's far more typical for parents to make regular contributions over time but ...

For small amounts, I like the Savings Bonds for Education program because the bonds stay registered in your name, and if you need the money for something other than college expenses, there's no tax penalty to redeem the savings bonds. (You do lose three-months' interest if you redeem the bonds within five years of the purchase date.)

If you don't have an emergency fund to cover three to six months worth of household expenses, this approach to college savings helps you accomplish that goal, too. Both the Series EE and Series I savings bonds qualify for this program.

This approach also avoids any account fees or annual expenses that you would have in a CESA or Section 529 account, and, like those accounts, investment earnings used for qualified-education expenses are free of federal income taxes. (U.S. savings bonds have always been exempt from state and local taxes.) Not all households will qualify for the Savings Bonds for Education program. See the Bureau of Public Debt's Web page for the income restrictions.

There are some tax advantages to the CESA and Section 529 accounts. Qualified distributions from CESA and Section 529 accounts are free of federal taxation, and in many states are also free of state income taxes, providing you invest in your home state's college savings plan. The College Savings Plans Network has a table that lays out the tax treatment by state.

Contributions to Section 529 College Savings Plans are made with after-tax dollars, but some states give you a tax deduction for contributing to your home state's college savings plan. Savingforcollege.com reviews the plans by state and helps you decide whether you want to invest in your home state's plan or to look elsewhere. Especially helpful is that site's Section 529 Plan Evaluator and five-mortarboard rating system.

Of course, the key thing regardless of which type of college investment account you choose is to get started. The sooner you start investing for his college expenses, the easier it will be to reach that financial goal.

-- Posted: Feb. 22, 2002