Key to college savings success: Keep the money in dedicated account

If your kids' college savings are not walled off in some kind of separate account, how do you keep yourself from raiding the kitty?

Stephanie Sadural Heincker is one mom who does not trust herself: She has an automatic deduction from each paycheck go into 529 college savings plans for her children, 2 and 4.

Heincker's own parents dipped into the money they had set aside in a savings account for her, so she ended up saddled with a lot of student debt.

"This is the least I can do to try to smooth the path for my kids a little bit," said the 36-year-old from Indianapolis.

The number of families saving for college is at an all-time high, according to new data released last month from Fidelity Investments. But a large portion of parents do not keep college savings separate, leaving money earmarked for education vulnerable to emergencies or luxuries.

Since Fidelity started measuring college savings rates in 2007, the number of families who said they are saving has jumped 24 percentage points, from 58 percent to 72 percent today. But among those who are saving now, only 42 percent use a dedicated savings account, such as a 529 plan.

The reasons for commingling savings ranged from simply preferring it that way to confusion about account types to apathy about getting started.

Take one of financial adviser Levi Brandriss' clients from Bethesda, Md., who kept the money stashed for college in a savings account, intending to roll it into a 529 plan. The clients stalled because they were concerned about what would happen to the funds if their child did not go to college, or did not need all that they had saved.

In the meantime, they decided to use that money to buy a vacation property.

Vickie Adams, a financial adviser who specializes in divorce issues in Manhattan Beach, Calif., has had many clients with nebulous chunks of money that were originally supposed to go toward college funds. She said that money often gets divided up and used to pay legal fees and other expenses.

"But when there is a 529 plan, nobody ever thinks of invading that; they are sacrosanct," said Adams.

In 24 years of practice, she has only had one case where a parent went into a dedicated college fund and took out money, and that was a spouse who also committed tax fraud.

Some college savers prefer to have more sophisticated investing options than are available in most state 529 plans. Some are seeking lower fees. Some do not want to be locked into only spending the funds on educational expenses. Some eschew the volatility of the stock market.

One choice for these investors is to consider a Roth IRA as part of their college saving strategy. Contributions can be withdrawn penalty-free after five years, while the growth stays in and continues to build tax-free.

But this is risky for parents if the Roth is part of their own retirement strategy. "It sounds clichéd: You can't borrow for retirement, but you can borrow for college," said Keith Bernhardt, Fidelity's vice president of retirement and college products.

High-net worth families could also consider zero-coupon municipal bonds, said Jonathan Swanburg, a financial adviser for Tri-Star Group in Houston.

In states like Texas with no income tax, Swanburg's clients often look beyond 529 plans. For those worried about stock market volatility, bonds offer low risk and a comparable return over time, given that most age-based investment plans get more conservative as children get closer to college age.

"It's not the solution for everyone. This is for where a person says 'I hate volatility and I don't want to pay tax and I want to remain flexible,' " Swanburg said.

On the opposite end of the spectrum, Stephanie Sadural Heincker supplements her 529 plan with a walled-off savings account tied to an app called Qapital (qapital.com), which rounds up change from her debit card transactions. It's a few cents at a time, but it makes her feel better.

"Something about the psychology of having that separate account just works," Sadural Heincker said.