How CDs can help parents save for college
If you think saving for college by investing in the stock market is too risky, a savings strategy that incorporates CDs might be right for you.
Indeed, there are no easy choices for parents trying to figure out how to pay for college.
It's just flat out expensive. And it's getting more so.
In fact, between 2005 and 2009, college tuition increased 6.5% on average each year, according to the Bureau of Labor Statistics, while the Consumer Price Index increased 2.5%.
The conventional savings route for many parents is to use a state-sponsored 529 plan.
These tax-advantaged plans, named after a section of the IRS code, offer a variety of investment options that are designed to grow college savings.
Sounds simple, but these plans have proved to be more volatile than anticipated.
When the stock market tumbled in 2008 and 2009, some 529 plans actually fell in value by as much as 80%. The performance was so bad that state attorneys general in some cases filed lawsuits.
But if you can't stomach the risk, you can use certificates of deposit to save for college.
Stock market returns beat CD yields over the long-term, but one thing is certain.
At least with CDs you never have to worry about your college savings losing money.
Here are three options that will keep your college savings fully FDIC-insured:
Option 1. Set up a ladder.
A CD ladder designed to help pay for college is easy to set up. Simply extend your maturities out at regular intervals, and when rates go up you will start earning better rates of return.
If college is far off, you should take advantage of the long-term certificates that offer the best rates.
Will your ladder keep up with college tuition inflation or stock market averages?
But it might be closer than you think.
When financial advisors point out the inadequacy of certificates as a long-term investing tool, they invariably point to the historical returns based on the national average.
But if you use our website to track the best rates, you aren’t settling for "average."
Instead, you are turbo-charging your ladder with some of the highest rates available.
And those rates tend to be a lot closer to the rate of inflation -- and even stock market averages -- over the long-term than most people think.
Use our easy CD ladder calculator to see just how much money you can save using a long-term ladder.
Option 2. Search credit union deals
Finding CDs to use for college savings is easier when you include credit unions in your search.
Credit unions tend to market their products to smaller groups, which can allow them to offer some great deals to their members.
In some cases, credit unions even target kids.
A great example is Gateway Community Credit Union based in Missoula, Mont.
This local credit union has a 5-year certificate paying 8.00% APY.
That’s right, an 8% return without risking your money in the stock market.
The certificate can be purchased for children up to the age of 13. This means that if you buy the CD for a 13-year old, you can ride that 8% rate all the way to the first day of college.
Here’s the catch: the credit union only allows a maximum deposit of $2,000 per account.
So you can’t plan on an 8% return for all of your college savings. You have to shop around for more rate deals.
Credit union deals like this one are typically local deals.
The personal finance blog, Bankaholic.com, tracks rate deals for banks and credit unions.
Option 3. Find a CD indexed to college tuition.
If you purchased a traditional certificate of deposit, you're stuck with that yield until maturity (unless you withdraw early) regardless of what happens to rates -- and college tuition -- in the future.
But we found one bank that offers variable-rate certificates that increase as tuition increases.
College Savings Bank (www.collegesavings.com), located in Princeton, N.J., offers certificates of deposit with maturities ranging from 1 year to 22 years.
Its CollegeSure CDs make an annual adjustment to the rate based on the change in the College Board’s Independent College 500 Index for the preceding year.
That keeps your savings accelerating as tuition costs increase.
CollegeSure CDs have limitations when compared to regular certificates.
The actual interest rate that you earn is complicated to compute.
You don’t earn the full annual increase in college tuition. Instead, your rate is reduced by what the bank calls an issue margin. This margin, which ranges from 2.25% to 3.50%, is set when you buy the certificate and is based on the term you pick.
Interest rate caps also are applied based on when you purchase the CD. The cap further limits your potential to fully track college tuition costs.
If that wasn’t enough, you also run the risk of earning 0% if the rise in college tuition isn’t high enough to cover your interest margin.
And right now, these certicates are actually paying far less than the best fixed-rate CDs. But if tuition costs skyrocket, you'd have the potential to earn as much as 4.90% APY.
These aren't for everyone, but they are an option for parents who can’t stand the thought of losing their college savings in 529 plans that invest in stocks and bonds.
Unlike a 529 plan, you can’t lose money with this deal as long as you stay within the FDIC insurance limits.