Ways to save for college

One way to offset some of the risk you take when you invest in stocks and most bonds is to put some of your money in insured bonds and CDs. These investments limit the risk you take because they guarantee return of principal and at least some earnings. Better yet, certain bonds and CDs offer extra incentives — in the form of tax breaks and higher interest rates — for investors saving for college. Just remember that these bonds and CDs alone probably won’t earn enough interest to cover the cost of college, since investments that carry limited risk also have limited potential return.

How savings bonds work

When you purchase a US savings bond you lend money to the US government. Your loan earns interest that’s free of both state and local income tax — and federal income tax, too, as long as you use your savings bond to pay for your beneficiary’s qualified higher education expenses and meet certain requirements. But you can neither trade nor resell savings bonds to other investors as you can stocks and other bonds.

The US Treasury issues two types of savings bonds:

  • Series EE bonds are sold either online at www.TreasuryDirect.com or in paper form and pay a fixed interest rate. They are guaranteed to mature, or reach full value, after you’ve held the bond for a certain period of time — 20 years for bonds issued after June 2003.
  • Series I bonds are sold at face value. These bonds earn interest that’s indexed to the rate of inflation

Both types of bonds can be redeemed any time after they’ve been held for 12 months, though you will forfeit three months’ interest if you redeem your bond before five years pass. Just keep in mind that the longer you hold your savings bond, the more interest it will earn. And unlike assets in tax-free accounts that you must use for higher education expenses or face a penalty, you can use the income from savings bonds any way you like.

Low-Risk investment options

US Savings Bonds (Series EE)

  • Cost: $25 and up
  • Term: 12 months to 30 years (with a penalty for redeeming before 5 years)
  • Rate: Fixed on new bonds or 90% of market yield on 5-year Treasurys for those issued before June 2003
  • Tax benefits: Free of state, local, and sometimes federal income tax
     

US Savings Bonds (Series I)

  • Cost: $50 and up
  • Term: 12 months to 30 years (with a penalty for redeeming before 5 years)
  • Rate: Indexed for inflation
  • Tax benefits: Free of state, local, and sometimes federal income tax

Baccalaureate Bonds

  • Cost: $1,000 to $5,000
  • Term: 5 to 20 years
  • Rate: Indexed to market performance
  • Tax benefits: Free of state, local, and sometimes federal income tax

CollegeSure CDs

  • Cost: $250 and up
  • Term: 4 to 22 years
  • Rate: Indexed to college costs according to Independent College 500® IC Index
  • Tax benefits: Taxable unless invested through Coverdell ESA or certain 529 plans

Savings bonds for college

If you use your savings bonds to pay for your beneficiary’s tuition and mandatory fees, you may qualify for the full tax break. But as the owner of the bond you’ll have to fulfill certain requirements first. You must be at least 24 years old at the time you purchase the bond. And although you aren’t required to declare your beneficiary until you cash in your bond, you must be sure of two things:

  • That the beneficiary is not named owner or co-owner of the bond
  • That at least one owner is a parent of the beneficiary

In addition, your AGI must fall below an annually adjusted amount in the year you withdraw the savings for you to be eligible to use the money tax free. But the cap is high enough to allow many families to take advantage of the benefit and has gone up every year. When your child is ready to enroll, you can find the income limit that applies for the year on the IRS website at www.irs.gov or in IRS Publication 970. 

Baccalaureate bonds

Certain states may issue baccalaureate bonds, also known as college savings bonds, which typically cost between $1,000 and $5,000 and have terms of 5 to 20 years. These are zero-coupon bonds, which means you receive no regular income payments and instead receive a lump-sum payment when the bond matures. In order to qualify for these bonds, you must be a resident of the state and use the bond to pay for tuition at in-state public schools. But your earnings accumulate tax free, with no limits on your AGI. And certain states may offer you discounted tuition at qualified institutions. 

An eye on the clock

Make sure you time your bond and CD withdrawals wisely. If you redeem these investments before their terms are up, you may face a penalty or forfeit some interest. Plus, the earlier you redeem your bond or CD, the less interest it will have the opportunity to earn.

 

College? Sure!


If you’re investing for college, you may also want to consider a CollegeSure CD, which is issued by the College Savings Bank of Princeton (NJ). When you invest in these CDs, you purchase units, or one year credits, toward future college costs at today’s rates, plus a premium based on your beneficiary’s age and the amount you invest. Your account is indexed to average tuition, fee, and room and board costs, according to the Independent College 500 IC Index. However, you’ll owe taxes on your earnings — unless you invest through an ESA or participating 529 plan.

For example, suppose you invest $10,000 in a 15-year CollegeSure CD. Your investment pays for 0.25 units, which is worth $8,000 today. In 15 years, if 0.25 units are worth $18,000, you’ll be able to withdraw that full amount, minus taxes.

Of course, when you first invest in your CD, it’s hard to predict how much college will cost you. But you can be sure your investment will at least match indexed costs when your term is up. Like other CDs, CollegeSure CDs are FDIC-insured up to $250,000 per account. And even in the unlikely case that college costs decrease, your CD is guaranteed to earn at least 2% each year.

 

 

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