Using CDs for college savings

Because of its guaranteed return and fixed maturity date, a certificate of deposit (CD) can be an ideal college savings vehicle. This article explores some of your options for using CDs to help fund future tuition payments.

Building a CD ladder for tuition payments

Sending a child to college means that you face a regular schedule of payments - most likely, twice a year until that student completes the program. That means making sure the money is available when you need it. While you may choose to invest college savings in growth vehicles such as stocks when your child is still several years away from college, these investments are prone to significant fluctuations in value. So, as your child approaches college, it can be a good idea to shift your investments to more conservative accounts.

Of course, there are other deposit vehicles, like savings and money market accounts, that offer safety and liquidity. However, you can typically get a better return in a long-term CD. One way to get a better return but have the money ready when you need it is to build a CD ladder based on your planned tuition payments.

A CD ladder is a series of CDs with different maturity dates. In this case, you could buy a series of CDs with maturity dates timed shortly before you expect tuition payments to come due. This way each component of your CD ladder should be able to earn the best rate it can right up until the money is needed.

A bridge from your 529 plan

What if you are already using a 529 college savings plan? These college saving plans have an advantage over CDs in that their investment earnings are free from taxation. That tax advantage is of greatest benefit with higher-returning growth investments over the long-term.

However, once your child enters high school, you might want to start channeling any new savings into a CD rather than your 529 plan. With college just a few years away, the tax advantage of a 529 plan is of lesser benefit, and once you are ready to downshift away from growth instruments you may find CDs offer a better return than the conservative options in a 529 plan - especially when fees are considered.

Choosing the right CD

If you like the idea of using CDs for college savings, here are some steps you can take to implement this program:

  1. Check your tuition payment cycle. Since long-term CDs have better yields than short-term ones, choose as long a CD as possible but make sure the money becomes available before you need to make each tuition payment. This way you can avoid early withdrawal penalties. Find out the billing schedule for tuition, and choose CDs scheduled to mature at least three weeks before each due date, in amounts roughly matching each payment.
  2. Shop for the best rate. This can make a big difference. For example, MoneyRates.com tracks some 5-year CDs that offer nearly three times the national average rate.
  3. Check for rate changes with each new CD. Since you may be buying CDs at different times to prepare for payments from freshman through senior year (and perhaps beyond), don't assume that the same bank will always have the best rate. CD rates can change a great deal over the course of a year, and banks react to those changes to varying degrees.

Involve the future college students in your household in the process of structuring your CD ladder and searching for rates -- it can be a great teaching opportunity. After all, since a college degree should help them earn a better income, knowing a little about how to manage the money they'll earn is a good idea.

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