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Life Insurance --- The Ideal College Funding Tool?

May 23, 2017

Today, as competition for jobs heats up, a college diploma is imperative to just get in the door.  It can also be extremely expensive.  The price of in-state and out-of-state college Cost of Attendance (including most, but not all expenses) now runs from a rare low of $14,000 to over $62,000 per year.  These costs are rising 5 to 8 percent each year. So, for a young child, the 4-year cost of higher education could well be more than the cost of a home today!

To offset all or part of that expense, many parents, grandparents, or other relatives wisely start saving early for a child’s higher education. 

The primary objective is to securely harness the effect of compound interest on the dollars being saved. Over 12 to 18 years, the snowball effect will grow these funds exponentially.  For example, a $5,000 deposit plus $1,000/month for 12 years at 6.00% would be $221,454.  At 7.00% it would be $237, 554.  If the period was extended to 17 years, the values would be $368,828 and $408,780 respectively.  Add another early deposit of $10,000 and the effect of the "Eighth Wonder of the World' is even more obvious:  @ 6% $241,155 or  $392,544; @7% $258,751 or $434,510.

Some parents simply plan to use regular bank or investment accounts to save for a child’s education. Unfortunately, money in these vehicles is taxable and may be taxed again, when withdrawn, as capital gain. 

Others choose a 529 college savings plan. The money in these accounts grows tax-deferred. However, when the funds are withdrawn, they must be used only for education-related expenses. If not, penalties and taxes could result. Further, these accounts are exposed to Market Risk, subject to severe loss if markets decline.

Another choice we see is to use parents’ pension plans to pay for their children’s education. This “solution” should be nixxed from the start. Such a plan is untenable for multiple reasons, including those above.

The Better Way.  Alternatively, there is a better way that allows tax-deferred compounding, flexibility to use the funds for non-college costs, and for spending to be income-tax-free. This is through the use of a properly structured permanent life insurance contract.

Structuring Life Insurance to Reach College Savings Goals.  Typically, types of permanent life insurance such as whole life or universal life work well as college funding vehicles. There are different ways the insurance plan can be structured: to emphasize the growth component, the death benefit, or a balance of both. Policies may be placed on the life of the child or on the life of a parent or guardian. Depending on how the plan is set up, there can be a number of benefits, such as:

  • Funding from tax-deferred cash value build up.  By putting life insurance coverage on the life of the child, funds in the cash value account offer tax-sheltered growth and flexibility in the use of the money. When a child is young, parents may take out a life insurance policy on the child – provided he or she is healthy. Even a very large policy may be purchased for a relatively small premium. In these cases, the child is the insured with a parent/relative as the owner and beneficiary. As premiums are paid into the policy, the cash value can grow exponentially, free of taxes. When it is time for the child to attend college, the parents may cancel the life insurance policy and withdraw the cash – subjecting the gain to income tax.  Or, better, they keep the policy in force and borrow against the cash value at a low guaranteed interest rate, possibly also withdrawing some of the monies paid in as premiums. By choosing the latter route, the cash value is accessible income tax-free.
  • Securing completion at the death of the insured.  An insurance policy may also be placed on the life of one or both parents (or grandparents), with the child or a trust as the beneficiary. In this case, should that insured person pass away, the child’s higher education may be assured by the income tax free proceeds of the life insurance contract. If the parent or other insured is still alive, the cash value of the policy can be used as above.

Taking the Next Step.  There are several choices and a few caveats that must be weighed to develop a College Funding Plan. Which policy design(s) will ensure that – no matter what – money will be available to pay for all or most of higher education expenses?  Ideally, a college funding strategy should also maximize potential qualification for Financial Aid as well as consider family needs and preferences.

The younger your children, the sooner you start, the more choices you will have.

To explore your College Funding options, call us to schedule a 6-point College Funding Review.