7 Ways To Invest If Your Kids’ College Investments Are Not Earning Enough

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There are many routes to saving for your children’s college education, but one of the most commonly recommended is the 529 savings plan. This is a tax-advantaged investment account in which the earnings in the account are tax-deferred and withdrawals are tax-free so long as the funds are spent on education-specific needs. Some of these plans can also be rolled over into IRAs later in life if your child chooses not to go to college.

However, as with any type of account with funds that are invested in the market, sometimes they just don’t perform very well.

If the investments in your child’s college fund aren’t performing well, what else can you do? Financial experts weigh in.

Also see how much college costs in each state.

It’s Not About the Right or Wrong Investment

Jack Wang, a wealth advisor and financial aid advisor at Innovative Advisory Group, urged a reframing of your accounts, even if performance is low. Instead of thinking about having a “wrong” or “right” investment, consider that “financial aid is a form of tax-free return.”

He said instead of choosing different investments, there may be a way to reposition the money into an account type that is not considered for financial aid.

For example, the assessment rate for assets on a Free Application for Federal Student Aid (FAFSA) is 5.64%, and it’s 5% on a College Scholarship Service (CSS) Profile, he explained. Thus, if assets are not counted for those, it is like earning another 5%-plus in the form of financial aid.

“One example of repositioning indirectly for aid could be taking money out of a CD but then putting saving extra in a 401(k). The family could use the CD proceeds while income is lower due to the extra 401(k) deferrals,” he explained.

But Don’t Hurt Your Chances for Aid

However, if changing investments to try to earn a better return leads to incurring costs or income items, such as capital gains, that can really hurt chances for aid. Income items on FAFSA are assessed on a sliding scale between 22% and 47%.

You’ll have to weigh which route ends up being more financially smart in the long run.

Think More Tax-Efficiently

Yes, earning more is good, but your after-tax return is what counts, Wang said. “This could mean investing in a tax-efficient manner, or using tax strategies to pay less in taxes. For example, a family may want to gift investments to the student (if need-based aid is not a consideration), as the student is likely in a lower or zero tax bracket while the parent may be in a high tax bracket.”

Custodial Accounts

Custodial accounts — such as Uniform Transfers to Minors Act (UTMA) accounts and Uniform Gifts to Minors Act (UGMA) accounts — offer flexibility in investment choices, according to Darian Shimy, founder and CEO of FutureFund.

“With the assets moving to the child’s control at a designated age, these accounts let adults handle investments on behalf of a minor,” he said. “They give the chance to invest in a variety of assets, so they may yield more returns than more limited college savings plans.”

However, these accounts are regarded as the child’s assets, Shimmy said. Therefore, their impact on eligibility for financial aid is greater than that of parent-owned accounts.

I Savings Bonds 

This type of savings bond is a low-risk option that can be particularly attractive during periods of high inflation, Shimy said. 

“These bonds guarantee that your investment keeps current with inflation by combining a fixed interest rate with an inflation-adjusting rate,” he explained.  

This function makes I bonds a great option for maintaining the buying power of your college savings. Additionally, they’re one of the safest investment choices available, since they’re backed by the U.S. government.

Roth IRA for Kids

Roth IRAs aren’t only for retirement; they can be an innovative way to save for college too, Shimy said. 

Your child does have to earn an income, however, to be eligible for one in their name.

“Although they were created mostly for retirement savings, Roth IRAs give flexibility for educational costs. Contributions can be taken penalty-free for qualified education expenses; withdrawals at any time are not penalized,” Shimy said.

If the money isn’t needed for college, this dual-use account can give tax-free growth and the extra advantage of starting retirement savings, he explained.

Whole Life Insurance Cash Value

Another avenue for a child’s future college savings is whole life cash value insurance, which has become extremely popular lately, according to Bryan Schod, CFP, a managing associate with Luttner Financial Group. According to MarketWatch, “The cash value of a permanent life insurance policy can function as a tax-deferred savings or investment account.”

This guarantees that the child will have whatever specified amount you plan for at certain ages, he explained.  

“The parents stay in full control of the money or can transfer ownership to the child if they choose. They get an extremely cheap life insurance benefit so the kids don’t need to buy life insurance later in life, and they don’t have to use it for college if they don’t want to,” he said.

Other benefits are that you can access the cash value tax-free if needed by taking a combination of withdrawals and loans.

This has become much more popular since children are now able to use the money for college or retirement. It grants significant flexibility while also adding in tax advantages.

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