Begin planning for a college education

Now is always the right time to save for college

Begin planning for a college education

Now is always the right time to save for college

Saving Strategies for Every Step

Investment Vehicles

There are several different investment vehicles to consider when you make investments for your child's college fund. In the interest of diversification, you may invest in more than one vehicle. Which vehicles you choose will depend on your ability and inclination to manage large sums of money, your tolerance for risk and how close you are to actually needing the money to pay for college.

Individual stocks rise and fall in value depending on the financial health of the company that issues them; they may or may not pay dividends. Bonds are known as fixed-income investments because they pay a set amount of interest at regular intervals. Mutual funds are available across the whole spectrum of risk and return, and are good vehicles for diversification because your dollars are invested in a number of companies all at once.

As you look at how much you anticipate your college investments to be worth when you cash them out, remember to take into account the tax impact of capital gains. With most investment vehicles, any increase in value will be taxable at the time you take the gain.

Savings bonds make sense for conservative investors, and may have tax advantages, especially if you redeem them in the year in which you pay your child's college tuition.

Individual Stocks

A share of stock is partial ownership in a company. Depending on the number of shares you purchase will determine your ownership percentage. Most often individual investors own a fractional percentage of any one company. Companies that offer stock for sale to the public are known as publicly-held companies.

There are different types of stock. Common stock is what people normally think of when they hear the word "stock." It is by far the most widely available kind of ownership. Preferred stock has certain protections against a company's financial troubles, but tends to grow more slowly in value. A corporation may also have classes of stock with different dividend policies, purposes or restrictions.

Many stocks pay dividends based on the profits of the company. These will generally fluctuate from year to year. Blue-chip companies pay the most stable dividends. Stocks with stable, high dividends are called income stocks. These are generally older, established companies. Young, growing companies may not pay any dividends at all. Instead, they will put earnings back into the company to make it grow faster. These stocks are called growth or aggressive growth stocks.

To purchase individual stocks, you typically need to open a brokerage account. Full service brokers typically charge commissions but they may provide you with more research and information, and could be appropriate for investors who desire professional assistance. Discount brokers charge you less, but you need to know what stock you want to buy or sell; they generally do not offer investment advice.


If you buy a bond, you are lending money. You might be making a loan to the government, or to the town where you live, or to a multinational corporation.

Bonds pay a set amount of interest at regular intervals and are known as fixed-income investments. Because the income is predictable, they are suitable for people who need income on which they can count. They are also very popular with people who don't like the fluctuations in the stock market. Short- and intermediate-term bonds are good investments for the intermediate term, when you know that you will need the money in three to five years.

Every bond has a maturity date (when the principal is paid back) and an interest or coupon rate. The interest rate is the percentage of par value that is paid out in interest each year. Par value is the amount printed on the front, or face, of the bond, and for that reason is also known as face value.

If you buy a bond at the issue date (when it first comes out), and you hold it until maturity, you will earn precisely the interest printed on the bond and get back its par value at the end.

If, however, you buy or sell a bond on the secondary market (after it has been issued), then its value will depend on the prevailing interest rates at that time.

Bond Type


Corporate Bonds

Generally more risky but higher yields than government bonds

Municipal Bonds

Exempt from federal taxes; may be exempt from state and local, too.

Treasury Bonds

Exempt from state and local taxes.

Treasury Notes

Exempt from state and local taxes.

Treasury bills

Exempt from state and local taxes.

Series EE bonds

Exempt from state and local taxes. If used for education may be tax-free.

Series I bonds

Exempt from state and local taxes. In addition, I bonds are inflation-indexed bonds. If used for education may be tax-free.

Agency bonds

Mortgage bonds are taxable; others are exempt from state and local taxes.

Corporate and municipal bonds are rated by services such as Moody's for their credit rating. If you want to buy individual bonds, you should check their rating. Treasury notes, bills and bonds are backed by the U.S. government.

Agency bonds are issued by federal and state agencies to raise money for their operations. Federal mortgage bonds like Ginnie Mae and Fannie Mae are some of the better known of these. They have higher risks than Treasuries.

Mutual Funds

When you purchase shares in a mutual fund, your dollars are invested in a large number of shares of many companies all at once, and your investment risk is spread out over many stocks of many companies, not just one. With mutual funds, your risk could be less because you are more diversified.

Mutual funds make it easy for you to invest in stocks and bonds. The two main advantages of investing your money in mutual funds are:

  • You receive professional money management; and
  • You are able to truly diversify your holdings with a relatively small sum of money.

Each mutual fund has one or more fund managers who are skilled in the principles of money management. They normally have access to large databases of research.

Each fund also has a particular objective. That objective is defined in the fund's prospectus. The objective could be long-term growth, current income, or a combination of income and growth. For example, the objective of XYZ fund is long-term growth. To accomplish the fund's objective, the fund manager invests the money received from its shareholders by purchasing shares of many individual companies that, in his or her opinion, have the potential for growth over time. The manager may also leave a small portion of the fund in cash. Some stock mutual funds can own shares of stock from a few hundred companies, thereby limiting their holdings in any one company to no more than 5–6% of all the assets in the mutual fund. This is true diversification, and your risk is less than if you invested in just one or two individual stocks.

You do not need a lot of money to get started in a fund. Some funds let you start with very low minimums.
One good way to invest in mutual funds is to have money automatically deposited from your checking account into the fund. This gives you the benefits of dollar-cost averaging and also ensures that you stick to your investment program.

Cash and bond mutual funds are the most appropriate as your child gets closer to college age. The blended funds (stocks and bonds) and stock funds are most appropriate when college is years in the future and you have a long-term investment horizon.

Types of Mutual Funds and Risks

Asset Class

Type of Fund



Specialty Fund

Most Risk

International Stocks and Bonds

International Fund

Global Stocks and Bonds

Global Fund


Aggressive Growth Fund


Growth Fund


Index Fund

Mostly Stocks

Growth and Income Fund

Mostly Stocks

Equity-Income Fund

Stocks and Bonds

Asset Allocation Fund

Stocks and Bonds

Balanced Fund


Corporate Bond Fund


Mortgage-Backed Bond Fund


Single State Tax Exempt Bond Fund


Municipal Bond Fund


U.S. Government Bond Fund


Money Market Fund

Least Risk

Capital Gains

A capital gain results when you sell a capital asset for more than the purchase price (cost basis). A capital asset is generally defined as an asset owned for personal or investment purposes. The tax rate on a capital gain is based on your marginal tax bracket and how long you held the asset before you sold it. In order for capital gains to be taxed at preferential rates, the combination of all your securities sales for the year must result in a net long-term capital gain. In other words, after you offset all your capital gains and losses for the year, you must end up with a net long-term capital gain.

The maximum tax rate on net long-term capital gain is generally 15% (20% for those in highest marginal tax rate) for many taxpayers. For those in the 10% or 15% bracket, the rate is 0% (according to current laws this is until 2016). Investments must be held for more than one year to qualify for these preferential rates. Gain on property held for one year or less is treated as short-term capital gain, subject to tax at the same rates as ordinary income.

Taking advantage of these rates will ease the tax bite when you are ready to sell your investments for cash to pay college tuition bills.

Savings Bonds

Savings bonds may make sense for conservative investors. They are lower risk than most investments since they are backed by the U.S. government. Since these bonds earn interest for up to 30 years, they can be used for long-term goals such as education and retirement. They are good for a forced-savings program to make sure you do not spend the money on something other than your goal. Savings bonds are issued by the U.S. Treasury and are available online at the Treasury's web site, and may be available through your employer via payroll deduction.

Series EE and Series I bonds have tax advantages—you will not have to pay state or local tax on the interest earned, and federal tax can be deferred until you redeem the bonds or they reach maturity. In addition, you may be eligible to exclude all, or a portion of, the interest if you redeem the bonds in the year in which you pay your child's college tuition. Series EE and Series I bonds purchased after 1989 that are redeemed to pay college tuition may not be taxed at all if the parent's modified adjusted gross income falls below a certain dollar amount and other requirements are met. See the section called Tax-Saving Investment Vehicles for more details.

Series EE Bonds

Series EE bonds, previously issued in paper form, were sold at one-half of their face value. For example, a $50 bond would cost $25, and a $10,000 bond would cost $5,000. New bonds are now held electronically via TreasuryDirect and are issued and purchased at face value. You may purchase any amount over $25 up to $10,000 per calendar year for each social security number. Series EE bonds issued after May 1, 1995earn a fixed rate of return. Bonds issued from May 1997 to April 2005 earn a variable rate. Current bonds issued pay a fixed rate which is available on Treasury Direct.

A three-month interest penalty will apply to bonds redeemed within the first five years; these bonds are meant to be longer-term investments. Series EE bonds issued after February 1, 2003 must be held at least 12 months before they can be redeemed.

IMPORTANT NOTE: Bonds issued before May 1997 accrue interest every six months. If you cash in your bond before the accrual date, you'll lose up to six months interest. Make sure you check with your bank. Bonds issued after May 1997 accrue interest every month.

Series I Bonds

Series I bonds are inflation-indexed treasury bonds that are intended to encourage Americans to save more by offering protection against future swings in the cost of living. The Series I bonds earnings rate is a combination of a fixed rate of return determined at issue, and a semiannual inflation rate. The semiannual inflation rate is combined with the fixed rate of the particular Series I bond to determine the bond's earnings rate for the next six months.

Interest earnings are added to the Series I bond each month and interest is compounded semi-annually.
Series I bonds earn interest for up to 30 years, and twice a year the earnings rate can change to reflect any fluctuation in the semiannual inflation rate.

A three-month interest penalty will apply to bonds redeemed within the first five years; these bonds are meant to be longer-term investments. Series I bonds issued after February 1, 2003 must be held at least 12 months before they can be redeemed.

Series I bonds are offered at face value in the same denominations as Series EE bonds. Series I bonds are priced at face value. Thus, it will cost $50 to purchase a $50 Series I bond. Bonds held electronically via TreasuryDirect are issued and purchased at face value.

For the current rate on U.S. Savings Bonds, call 1-800-US-BONDS. You can also obtain the current rates via the internet at www.savingsbonds.gov.

Zero Coupon Bonds

These bonds are typically a lower-risk, reliable solution for conservative investors. It is best if you keep these investments for at least five years to take advantage of the accumulation of interest that these bonds offer.

Zeros get their name because they pay zero or no interest until they mature. That means you get all your interest in a lump sum when the bond matures at face value. For example, a $1,000 zero coupon treasury yielding 3.50% and maturing in 18 years, costs only $540 today. That means you invest $540 today and in 18 years you'll receive $1,000. To compensate for the missing/delayed interest rate payments, zeros sell at a steep discount from face value. You can purchase zeros with differing maturity dates so that you will receive the lump-sum amounts in the years when you need it—for example when your child is a senior in high school and for each of the following years of college. The lower-risk zeros are those issued by the U.S. Treasury.

SUGGESTION: A key advantage of zeros for financing college is that there are no semiannual interest payments as there are with regular bonds, so you can't spend the interest nor do you need to worry about where to invest it.

IMPORTANT NOTE: The trading prices of zeros can fluctuate significantly as interest rates move up or down. Price changes won't affect you, if you hold your bonds until maturity.

IMPORTANT NOTE: Although zero-coupon bonds do not pay interest until maturity, you must report the interest that accrues annually as income on your tax return. You can avoid this taxable income by purchasing tax-exempt zeros.

SUGGESTION: Zero coupon bonds are ideal for funding future needs such as your retirement or your child's college education. While you may not achieve as high a long-term rate of return as is possible when you invest in stock mutual funds, you do know exactly how much you'll be getting when the bond matures. Zero coupon bonds can help you "lock in" future amounts. Zero coupon bonds can be purchased through an investment representative.

Zero Coupon Municipal Bonds

These bonds, issued by many states, may be appropriate for conservative investors who are concerned about minimizing the amount of income tax they pay.

They are sold at a substantial discount from face value and therefore are within financial reach of many parents. In fact, they often come in denominations as low as $1,000. When they mature, you receive the full face value. These bonds, sometimes called baccalaureate bonds, issued at a set rate of interest. And, no matter how high your income, the interest the bonds earn is free from federal taxes and generally from state taxes for residents of the issuing states.

Because you'll get a lump-sum payment when the bonds mature, you know the exact dollar amount coming due, making it easy to plan for college bills.

Ask your investment representative to tell you about forthcoming issues. You can also call your state treasurer's office to find out when the bonds will be issued.

RFCU® does not provide tax advice. Please consult your tax advisor for your specific questions.

Must be eligible for membership and open a share savings account in order to obtain any product or service. A $5 minimum balance is required to open share savings account and must be maintained in share savings account at all times. Other restrictions may apply.