Iowa Insurance Division Iowa State University Extension Investor Protection Trust


Investing for College

Many parents and grandparents have as an investment goal saving for their children’s or grandchildren’s college education. “As long as your retirement goals are being taken care of, this is truly a gift to the next generation,” says Pat Swanson, CFP® and families specialist with Iowa State University (ISU) Extension’s Invest Wisely Project (

When investing for a child’s education, it is important to consider how long it is until the money is needed. The farther away college is, the more risk you can take. Parents and grandparents of newborns and toddlers might consider investing most of their money in stock and stock mutual funds. “The stock market will decrease in some years, as is occurring currently, but historically, over time, stocks have earned more than other investment categories,” Swanson says.

However, Swanson advises that if you have fewer than five years until the first tuition payment is needed, you will want to move your money from stocks into less risky investments such as bonds, certificates of deposit, or money market accounts. “And by the time the child is a college freshman you will probably want to have most, if not all, of your money in fixed income investments.”

Some parents and grandparents are concerned about the taxes paid on their investment earnings and withdrawals. With a custodial account – known as Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) – you invest in the child’s name. In 2007, the first $850 of a child's investment income was tax free and the next $850 was taxed at the child’s own rate. But any unearned income in excess of $1,700 in 2007 was taxed at the parents' tax rate.

“It is important to realize when setting up a custodial account that the child assumes control of the account at legal age and the funds might not be used as you initially intended. Also, they are counted as a student’s asset when student aid is calculated,” Swanson cautions.

Another popular way to save for college is the Coverdell Education Savings Account (ESA) – formerly the Education Individual Retirement Account (IRA). Up to $2,000 can be contributed each year for each child under age 18. “However, you cannot contribute to a Coverdell ESA if your adjusted gross income is $110,000 or more in 2007 --$220,000 if filing a joint return,” Swanson says.

If you qualify to open a Coverdell ESA, you can do it with a bank, brokerage, or mutual fund company and choose your investments from stocks, bonds, mutual funds, or cash equivalents. Withdrawals are tax-free if used for qualified education expenses before age 30. Distributions can be used for elementary or secondary school as well as college. The account can be transferred to a relative if not needed for the educational expenses of the beneficiary.

Another option is a 529 college savings plan, which is offered by most states. It is a tax-advantaged way to save for the future educational expenses of a designated beneficiary. Withdrawals are exempt from federal income tax when used for qualified higher education expenses.

“You may invest in the 529 plan of any state, but there are tax advantages to investing in the Iowa plan,” Swanson says. “When investing in Iowa’s 529 plan, called College Savings Iowa, earnings and withdrawals are exempt from Iowa state income tax when used for qualified higher education expenses. Iowa taxpayers also can deduct up to $2,685 in contributions, adjusted annually for inflation, per beneficiary from their state income tax. There are no income limits for contributing to a 529 savings plan.”

According to Michael Fitzgerald, State Treasurer of Iowa and administrator of the plan, Money magazine recently recognized Iowa’s plan as one of only five state plans whose strong management and low fees made them top choices not only for Iowans but for those living outside the state as well. “With more than $2 billion invested, we’ve continued to work hard to improve the program to provide individuals with the best way to save for college.” More information on Iowa’s plan can be found at .

Unlike a custodial account, the assets in a 529 college savings plan remain in control of the person who established the account. “And like with a Coverdell ESA, you can transfer the 529 plan account to a new beneficiary who is directly related to the original beneficiary if the state plan you have selected allows this,” Swanson says.
The number of investment options vary from plan to plan. “Typically you can choose from investment tracks. For example, there may be an age-based portfolio that has a higher percentage invested in stocks when the child is younger and shifts to bonds as the child gets older,” Swanson says.

When deciding which state’s 529 plan to enroll in, Swanson advises to consider enrollment fees, annual fees, tax advantages for residents, and investment options of the different plans. “You can roll your 529 plan from one state to another once a year.”


The ISU Extension Invest Wisely Project provides a series of newspaper, radio, and web resources for investors.  It is funded by a grant from the Investor Protection Trust (IPT).  The IPT is a nonprofit organization devoted to investor education.  Since 1993 the IPT has worked with the States to provide the independent, objective investor education needed by all Americans to make informed investment decisions.




Updated March 10, 2008