If you’re tired of the limited investing options in 529 plans, check out Coverdell Education Savings Accounts, the ignored stepchild of the college savings universe.

Long overshadowed by 529 plans, Coverdells offer major investment flexibility, allowing investments in anything from mutual funds to certificates of deposit to exchange-traded funds to individual stocks and bonds.

Because Coverdell Accounts can be established at almost any bank, brokerage firm or mutual fund company, they don’t labor under many of the restrictions that 529 plans do, which are sponsored by state governments, says Joseph Orsolini, a Certified Financial Planner with College Aid Planners in Glen Ellyn, Ill. As such, each 529 plan has a limited menu of investment options, which generally includes mutual funds packaged into age-based plans, asset-allocation funds and in some cases, individual mutual funds.

As the administrator of 529 plans, states charge fees to investors that are levied on top of regular mutual fund fees. “One huge advantage of the Coverdell is that you don’t have a sponsoring state taking its slice out of your return like you do with a 529 plan,” he says.

Go ahead, make an investment change

Besides the additional fees, investors in 529 plans are limited to one investment option change per year. There are ways to get around that restriction, such as moving assets from one plan to another or changing the beneficiary, but they’re a hassle, Orsolini says. “Coverdells place no restriction on changing investments,” he says.

One major uncertainty with Coverdells was extension of the the Bush-era tax cuts, which included Coverdell enhancements such as raising the maximum investment from $500 to $2,000 and allowing parents to use funds for kindergarten to 12th grade private school tuition, says David Munn, a Certified Financial Planner with Munn Wealth Management in Maumee, Ohio. In mid-December, Congress extended all of the tax cuts as part of a deal with President Barack Obama and he signed the bill into law.

Now, with the uncertainty removed, you can invest up to $2,000 for the next two years in a Coverdell, use the money to pay for college or private school tuition and enjoy the other benefits conferred by the Bush tax cuts, Munn says.

Coverdell accounts are easy to set up and use, but are better for investors who are willing to self-direct, select and monitor their own investments.

“Less-sophisticated investors will appreciate the simplicity of a 529 plan, where the age-based plans are clearly labeled, so it’s very easy for someone to deal with who doesn’t have a lot of investing experience,” says Munn. “With a Coverdell, there is a whole world of options that can be very overwhelming for someone who isn’t very investment-savvy.”

Among the options available to Coverdell investors are:

  • Certificates of deposit:
    Bank CDs carry no fees and are a simple, no-fuss way to invest Coverdell accounts. However, interest rates on CDs are so low now that investments will barely keep up with inflation, let alone the yearly increase in college costs of around 6 percent to 8 percent, Munn says.
  • Mutual funds: Unlike 529 plans, which are generally limited to a handful of choices from one or two fund families, the mutual fund options with a Coverdell are limitless, says Orsolini. You can set up a Coverdell through a mutual fund company and access an entire fund lineup or you can go with a brokerage account that allows you to access thousands of funds in hundreds of fund families.
  • Individual stocks: 529 plans don’t allow the purchase of individual stocks, but there is nothing stopping you from going in that direction with a Coverdell account. The only problem with this strategy is that it’s very difficult to build a diversified portfolio using individual stocks with the Coverdell limit of $2,000 per year, says Munn.
  • Individual bonds: As with individual stocks, 529 plans don’t allow the purchase of individual bonds. You can buy individual bonds via a brokerage account, but it’s also hard to be diversified with the Coverdell’s $2,000 limit.
  • Exchange-traded funds: ETFs are very similar to mutual funds, but have lower costs. They can get expensive if you pay brokerage commissions to buy and sell them, but several firms, including TD Ameritrade, Vanguard and Fidelity Investments, offer some ETFs on a commission-free basis.