Smart Ways to Save for a Child’s Education : Investing: Mutual funds are a great way to meet college bills, but don’t invest in a youngster’s name; the IRS can make it a truly taxing experience.

Thinking about investing some money in a mutual fund for your child’s education? Great idea. Just don’t invest the money in the child’s name.

That’s the advice of Raymond Loewe, president of Educational Planning Associates in Marlton, N.J., who helps parents figure out the smartest moves for meeting college bills.

Loewe notes that many parents try to save taxes by opening a Uniform Gift to Minors Account with their mutual fund company.

“Often, they end up losing more money than they set out to save,” he says.

The problem results from the way that the IRS imposes tax on children’s incomes. A child’s first $600 of investment income is tax-free, and the next $600 is taxed at the child’s low rate, typically 15%.

After that, the child pays tax at the parents’ rate, which might be as high as 39.6%.

Mutual fund sponsors will help you create an account for money that you invest on a child’s behalf. So why not let the kid have the money now, and take advantage of the tax savings? Two reasons.

First, the child gains total control over the money somewhere between age 18 and 21, depending on the laws in your state.

If he wants to spend it on parties, travel and automobiles, that’s his business, not yours. When your child is a toddler, or even a preteen, it’s hard to know if you can trust him to spend the money you’re saving now on an education later.

Second, by investing in a child’s name you may reduce your chances of getting financial aid when he goes to college.

Most colleges decide how much aid to give a student by using a complex formula that considers how much money the student and his parents have. They typically expect the student to contribute a much higher percentage of his savings to the cost of college--roughly 35% vs. 6% for his folks.

In other words, by giving the money to the student you increase the amount that your family is expected to contribute to college costs and decrease your chance for financial aid.

Best strategy: Forget about the tax break you’ll get by giving the money to the child when he is young. Instead, invest the money in your own name, and choose growth stock funds that can boost your returns over the long run.

The younger your child, the more aggressive you can afford to be. Parents of a child 10 or more years away from college might invest 75% of their college savings in growth stock funds. For example, Fidelity Equity-Income II (800-544-8888; no-load; $2,500 minimum initial investment) has a 44.4% three-year annualized average return. Manager Brian Posner’s value-oriented approach has kept it near the top of its sector.

Another choice, Lindner Fund (314-727-5305; no-load; $2,000 minimum), has a 25.7% three-year total return. The fund’s management team keeps risk low through a well-diversified portfolio mainly consisting of small-cap stocks.

You might also consider an international fund such as T. Rowe Price International Stock (800-638-5660; no-load; $2,500 minimum) which has returned 29.9% over the past three years.

The same parents could invest the remainder of their college savings portfolio in more stable bond funds. A solid choice: Vanguard Bond Index: Total Bond Market (800-662-7447; no-load; $3,000 minimum), which offers exposure to Treasury, mortgage and corporate bonds.

When a college-bound child enters high school, parents might consider shifting 50% of their portfolio to bond funds and money market funds so that the value of their college savings remains relatively stable during the students’ college years.

That’s also the time to consider shifting assets into a child’s name: By that age, you will have a better notion of whether you can trust the child to spend the money as you intend and whether he has a shot at qualifying for financial aid.

Moreover, after age 14, all of the child’s income, not just part of it, is taxable at his presumably low rate.

For example, say you have invested in stock funds that have appreciated sharply. If you transfer the fund shares to the child’s name before you sell them to pay tuition bills, the profit will be taxed at the child’s rate and you could save thousands of dollars.

Of course, none of this matters if you don’t save.

“Many parents never get around to putting money away in their own name or their child’s name,” says Loewe. “They’re the ones I worry about.”