Investing for Toddler College Fund

I have an 18-month-old boy, and one on the way. Depending on when the second is born, they may be one or two years apart in school. I'm overwhelmed by the idea of what college costs will be when my kids are in school.

--Lori
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Bruce Hammond

Bruce Hammond is an expert on college prep, applications and cost, and author of Discounts and Deals at the Nation's 360 Best Colleges and... Read more

Don't let yourself worry too much about all the speculation about what college will cost -- it is hawked by people wanting to sell magazines or financial services. College is getting more affordable, not less. Tuition this year rose about three to four percent -- pit that against whatever the stock market has done lately. If you put money away, you'll be fine.

The basic, universal advice is to invest in stock mutual funds. There's nowhere else that makes sense for someone looking at the long haul. However, there is choice among the vehicles you use -- IRAs, saving in the child's name, etc. Unfortunately, the water is muddied by the fact that the tax incentives and the financial aid incentives work in opposite directions. From a tax perspective, it may make sense to save in the child's name via a custodial account or Education IRA. But from an aid perspective, it makes sense to keep funds in your name because the aid formula "taxes" student assets at a higher rate than parental ones (at least until Congress changes the rules!)

So let me cut to the chase: if you've got lots of money (income $100,000+) and probably won't qualify for need-based aid, consider a tax-preferred custodial account or maybe even a trust. The new 529 savings trust accounts may also be an option. If need-based aid will be a priority, keep the funds in your name.

The Roth IRA is a good place -- ironically better than the Education IRA to save for college. You also may be able to borrow against your 401(k) so that may be a good place, too, though the drawback there is that your money won't be working for you while you borrow. The advantage of IRA's and other retirement funds is that they are not included in the formula that determines eligibility for aid.

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