Where to Stash Cash for College

From 529s to Coverdells to traditional investment accounts, here's a rundown of the best options for education savings.

A study by the College Savings Foundation found that more than half of the parents surveyed were unfamiliar with 529 plans or didn't understand how they work. Yet Fidelity Investments' College Savings Indicator found that parents who save in 529s are on track to cover more than half of their children's college expenses.

So perhaps a little explanation of your options will help you get a head start on saving for college.

1. State-sponsored 529 accounts. These are the best way to put aside money for college. Your savings grow tax-deferred and escape taxes altogether if you use the money for qualified educational expenses, such as tuition, fees, books and room and board.

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Families (including grandparents, aunts and uncles and even generous friends) can contribute regardless of income; minimum contributions are low and ceilings high. In about two-thirds of the states you can also get a state tax deduction or other tax benefits in exchange for your contributions.

And don't worry. Your savings won't hurt your chances for future financial aid. These accounts are considered parent-owned assets in the federal financial-aid formula, so they're assessed at a relatively painless 5.6%.

You can invest in a 529 plan through a broker, or sign up online with a direct-sold plan and put more of your money to work. The most popular type of investment is an age-based portfolio of mutual funds that becomes more conservative as your child gets closer to college. (Find the best state 529 plan for you.)

2. Coverdell education savings accounts. Like 529s, Coverdell accounts can be used tax-free for qualified educational expenses. But annual contributions are limited to $2,000 per beneficiary, and contributions are phased out altogether when your adjusted gross income is $190,000 to $220,000 if you're married filing jointly (or $95,000 to $110,000 for singles).

You can open an account with a bank or other financial institution and choose your own investments. And there's a bonus: Money in Coverdell accounts can be used to pay for expenses in kindergarten through grade 12, although that benefit is scheduled to expire in 2010 unless Congress renews it.

3. Alternative savings programs, such as Upromise or Futuretrust, deposit contributions automatically to a 529 account when you make purchases through the program. Even if you don't accumulate a lot of money, every little bit helps.

Also, don't discount garden-variety savings or investment accounts. True, you won't realize the tax benefits of 529s and other tax-advantaged programs. But you'll retain maximum flexibility, so you can use the money for your own retirement or some other purpose without penalty if your kids don't go to college -- or if they manage to win that elusive full-ride scholarship.

Janet Bodnar

Janet Bodnar is editor-at-large of Kiplinger's Personal Finance, a position she assumed after retiring as editor of the magazine after eight years at the helm. She is a nationally recognized expert on the subjects of women and money, children's and family finances, and financial literacy. She is the author of two books, Money Smart Women and Raising Money Smart Kids. As editor-at-large, she writes two popular columns for Kiplinger, "Money Smart Women" and "Living in Retirement." Bodnar is a graduate of St. Bonaventure University and is a member of its Board of Trustees. She received her master's degree from Columbia University, where she was also a Knight-Bagehot Fellow in Business and Economics Journalism.