Certificates for college savings: Planning for the future

With the cost of college tuition roughly doubling over the past two decades, it's more important than ever to start planning for higher education expenses well ahead of time. One often overlooked savings option is the certificate. With low risk and a guaranteed return, certificates provide a straightforward and secure way to start saving for future college expenses.

What you’ll learn

• Understanding certificates
• Benefits of using certificates for college savings 
• Strategies for certificates in college savings

Understanding certificates

Certificates are a type of savings account offered by credit unions; they are known as certificates of deposit (CDs) or time deposits at a bank or other financial institution. When you invest in a certificate, you agree to deposit a certain amount of money for a set period, known as a term. In return, the institution pays you a fixed interest rate, usually much higher than the annual percentage yield (APY) you'd earn on a traditional savings account. Terms can be as short as a few weeks or as long as five or more years. Longer terms are often rewarded with higher interest rates, but also require a longer commitment period.

The interest is compounded periodically (typically monthly) and credited to your account. Once the certificate reaches the end of its term, referred to as the maturity date, you receive your initial deposit plus the interest earned.

Certificates are known for their stable, fixed interest rates and low risk. They're insured up to $250,000 by the National Credit Union Administration (NCUA) for credit unions and by the Federal Deposit Insurance Corporation (FDIC) for banks, which ensures the safety of your principal.

Certificates do, however, come with an important catch: early withdrawal penalties. Withdrawing any funds before the maturity date can result in losing a portion of your interest or even some of your principal, depending on the terms and conditions set by the financial institution. The penalty typically ranges from a few months' worth of interest all the way to an entire year's worth.

Benefits of using certificates for college savings

Saving for college requires careful planning and a delicate balance of minimal risk and steady returns. The following are some of the main reasons certificates are particularly well-suited for college savings.

Low risk

Certificates are known for their safety and stability. Unlike stocks or mutual funds, which can fluctuate in value, certificates offer a fixed rate of return over a specified period. They also feature FDIC or NCUA insurance. This safety makes them a reliable choice for risk-averse investors who want to ensure their principal is protected. No matter what happens in the market, you won't risk losing your initial deposit.

Guaranteed returns

One of the most significant advantages of certificates is the guaranteed return they offer. When you invest in a certificate, the interest rate is fixed for the term of the deposit. This means you know how much interest you will earn, providing a predictable growth path for your savings.

No maintenance fees

Some financial institutions charge maintenance fees for keeping a savings account open, which can quickly eat into your interest earnings. However, most certificates don't feature any monthly maintenance fees, making them a cost-effective option for saving money. Just be sure to read the fine print and check for any hidden fees before opening a certificate.

Flexibility in terms

Certificates offer a range of term lengths, allowing investors to choose the timeline that best suits their needs. Short-term certificates can run for as little as three months, while longer-term options can range up to five years. More complex strategies like laddering, which involve investing in multiple certificates with varying terms, allow you to have access to your funds at regular intervals while still taking advantage of higher interest rates on longer-term options.

Strategies for using certificates in college savings

Incorporating certificates into your college savings plan can be a smart move to add stability and low-risk diversity to your portfolio. Here are some powerful strategies to help you effectively maximize their benefits.

Certificate laddering

Certificate laddering is a strategy that involves spreading your investment across multiple certificates with different maturity dates, allowing you to benefit from higher interest rates on longer-term certificates while still maintaining regular access to a portion of your funds.

To implement certificate laddering, start by dividing your total investment into equal parts. Next, invest each part in certificates with staggered terms, such as six months, two years and four years. As each certificate matures, reinvest the principal and interest into a new certificate with the longest maturity date available. By continuing this process, you create a cycle that provides regular access to funds and the potential for higher interest rates.

Timing your investments

Since these are fixed-term investments and college is a multi-year process, it’s important to align the maturity dates of your certificates with your expected college expenses. Begin by assessing your timeline to determine the number of years until the funds will be needed for tuition and other costs. Choose certificate terms that match this timeline, ensuring that the certificates mature when you need the funds. If your timeline changes or you need access to funds sooner than expected, adjust your certificate ladder by reinvesting in shorter-term certificates to maintain flexibility and meet your financial needs effectively. This approach helps manage the multi-year nature of college expenses while maximizing your investment returns.

Combining certificates with other savings options

While certificates provide a stable and low-risk savings option, combining them with other college savings accounts can optimize your financial strategy. Consider the following combinations:

1. Certificates and 529 plans:¹ Use certificates for short-term savings and a 529 plan for long-term growth. The 529 plan could offer tax advantages and high contribution limits, while certificates provide a fixed return for shorter saving periods.
2. Certificates and ESAs: For educational expenses beyond college, such as K-12 costs, an education savings account (ESA) can be paired with certificates to provide flexibility and possible tax benefits.
3. Certificates and high-yield savings accounts: Keep a portion of your savings in a high-yield savings account for liquidity and emergency use while investing the bulk in certificates for better returns.