The Late-Start Guide to College Savings

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Is your child hurtling toward college but you haven't given more than a few anxious thoughts to how you're going to pay for it?

Join the club.

For every parent who has been dutifully socking it away since the baby was in onesies, I seem to run into 10 more who feel like they're playing an unwinnable game of catch-up. School is drawing closer and tuition projections seem to grow more outlandish by the year. Most families who had begun saving for college probably saw their education funds drop sharply last year.

With mortgages to pay and sneakers to buy, many families have difficulty finding the extra money to save for college. But judging from feedback from my friends and acquaintances, a time crunch has been an equally important deterrent against creating a college-savings program. The alphabet and number soup of college-savings vehicles (529s, Coverdell Education Savings Accounts, UTMA/UGMAs) seems hopelessly complex--surely more than anyone could handle on a Saturday morning or a Wednesday night before going to bed.

Nevertheless, avoiding the issue won't make it go away, and the sooner you tackle it, the better off you are. Plus, there are a number of college-savings solutions out there that you might not have considered. Several make sense for a broad swath of parents, even those who think they're getting a late start.

Read on for a look at our best tips for getting going today.

Step 1: Resist the urge to stand still.
I'm a lifelong procrastinator; heck, as a high-school student I was once so behind on a term paper that I had to dictate it to my sister while she typed. (As you might expect, that was the first and last time she let me get away with that.) So, trust me when I say that I know the sick logic that we procrastinators employ. If I haven't done anything yet, you think, why start this minute?

But look at it this way. Thanks to compounding, a dollar saved today is much more valuable than a dollar saved 10 years from now. And even if you manage to save only a small amount between now and the time your child is ready for college, he or she is going to have to borrow that much less for tuition. The key is taking that first step.

Step 2: Don't play catch-up by chasing overly risky investments.
Instead of sitting still, some parents who fear that they won't be able to afford skyrocketing college costs might be tempted to do the opposite: swing for the fences in the hope of hitting it big.

But as anyone who bought an Internet stock in the late 1990s or an emerging-markets fund in early 2008 will tell you, investments that have posted big past returns often carry extreme risks. Thus, the best way to save for college isn't to concentrate in a single risky stock or sector but instead to build a well-diversified portfolio with a stock/bond mix that suits your child's time horizon. Bear in mind that if your child's college years are drawing near, you'll want to be taking fewer risks with any money you have earmarked for college, not more. While savings for children under 10 may safely be invested in stock funds, storing more and more of your child's college savings in cash and bonds as they make their way through high school is sensible.

True, bonds and cash don't have the same return potential as stocks do. But if you're afraid that your college savings will come up short when it comes time to matriculate, your best option is to plan to save more, or plan to rely on loans and financial aid, rather than venturing into inappropriately risky investments.

Step 3: Consider a 529 plan.
529 college-savings plans have their downsides, which include high expenses and substandard investment choices. And several plans got caught with overly risky investments in 2008. But given that 529s permit extremely generous contributions and offer tax benefits to boot, these programs can be ideal for late-start college savers who need to sock away as much as possible in a short period of time. The key is to choose carefully.

Although Section 529 prepaid-tuition programs essentially allow you to lock in today's tuition rates, such plans can be somewhat inflexible. You may also be able to earn a higher rate of return by investing on your own. This article details the ins and outs of prepaid plans.

In contrast to the prepaid programs, money invested in Section 529 college-savings plans can be used at any college in the United States. There are no earnings restrictions on who can contribute to a 529 plan, and you can contribute up to $65,000 per year per child without triggering the gift tax ($130,000 for joint filers). Flush 529 savers could, in theory, sock away enough in a single year to cover a child's complete education. Your contributions to a 529 plan can grow free of federal taxes, you can take tax-free withdrawals to pay for college expenses, and you may also enjoy a state-tax break. Finally, the 529 assets are held in the parents' name, meaning that these assets receive more favorable treatment than the child's assets, such as UTMA/UGMA accounts, in financial-aid calculations.

Not all 529s are created equally, however. Although you may enjoy a state-tax break by sticking with your own state's plan, high costs and poor investment returns could outweigh that benefit. Thus, it pays to shop carefully and to look beyond your home state's plan if it's not up to snuff. Morningstar provides you with a snapshot of the various states' plans here. And to find out which plans our analysts consider best of breed (and those they consider the nation's worst), take a look at this article.

Step 4: Simplify with all-in-one funds.
For college savings, I'm a fan of funds that "mature," or grow more conservative, as the child nears college age. (The closer your child is to needing to tap into those assets, the thinking goes, the less fluctuation you want to see in your principal value.) Many 529 plans feature such one-stop, "age-based" options, and they make perfect sense for parents who would prefer to select a plan and tune out.

If the costs and complexities of 529 plans lead you to opt to save for college in your taxable account or via a Coverdell Education Savings Account (the old Education IRA), you can still take advantage of all-in-one options. Most of our Analyst Picks in the conservative- and moderate-allocation categories would serve as fine stand-alone options for college savers, though such funds maintain static asset allocations rather than grow more conservative over time. Moderate-allocation funds are appropriate for those with intermediate time horizons, while conservative-allocation funds would work well if college is five to 10 years away. If you're just starting to save for college and don't have a lot to invest, it's hard to go wrong with a well-diversified, no-nonsense fund like Vanguard STAR (NASDAQ:VGSTX - News), which has a $1,000 minimum.

Step 5: Cheap out.
If your investment horizon is relatively short, it's all the more important to pay attention to how much you're shelling out in fund fees. That's because cash and bonds--which should form the bulk of your child's portfolio as college draws near--have low returns to begin with. If you layer on excessive expenses, your take-home return will be that much lower. For your college-savings plan, focus on stock funds that charge less (preferably much less) than 1% per year in annual operating expenses; look for bond funds with expense ratios of 0.75% or lower.

For similar reasons, late-start college savers will want to be careful about how much they're shelling out in brokerage charges and other administrative fees. Morningstar's College-Savings Center includes details on 529 fees and other administrative expenses associated with each state's plan.

Step 6: Accentuate the positive.
Even if you haven't established a dedicated college-savings fund, you have other options at your disposal. Parents might also consider tapping their own Roth IRAs to pay for college, for example. If you are interested in walking through some of these options, take a look at this article.

Regardless of your savings vehicle of choice, we'd encourage you to meet the college-savings challenge head-on. Addressing the issue sooner rather than later will likely save you lots of headaches down the road.

Christine Benz does not own shares in any of the securities mentioned above.

A version of this article appeared Sept. 30, 2008.