Life Insurance for College Savings
Everybody wants their children to acquire a college education to secure better jobs and a bright future. But not everybody has the resources to meet the high college fee expense. Therefore, many parents consider savings long before their child starts college. However, saving for college is equally daunting because parents are not well-informed about which savings plan to choose.
The two most popular and best college savings plans are the 529 plan and life insurance for college savings. They come with their advantages and disadvantages, which you must evaluate first to select the right option. Read on as we’ll provide complete details on the best college savings plans and alternatives to help you make an informed decision.
Life Insurance for College Savings
Although the main purpose of a life insurance policy is to provide a death benefit to the beneficiaries, it can also be used to fund the child’s college education. This is possible if you have a cash-value life insurance policy.
This option is available if you buy a permanent life insurance policy. Unlike term life insurance coverage, the permanent life insurance policy offers a tax-deferred savings element that can help you arrange an insurance savings plan for your child’s college funds.
Permanent life insurance works as a vehicle for college savings. Every time the policyholder pays in premiums, one portion of this amount goes to their death benefit, while the other goes to the cash-value account.
Let’s look at the two types of permanent life insurance:
Whole Life Insurance
Under this policy, the insurance policy issuer credits the holder’s account with a guaranteed amount. However, it can pay you more based on the performance of the investments. Policyholders can expect a return of around 3%–6% after several years. At the same time, the money in your cash-value account continues to grow tax-deferred. This money can be used as education insurance. Read on to find out how.
Variable Life Insurance
Under this policy, you have a certain degree of control over your investment. For example, you have the flexibility to select the sub-accounts that you would like to attach to your insurance policy. The annual return of the account is pegged to the performance of your investments. Even though the potential reward is greater, it’s still risky because the balance can fall depending on the market swing.
Moreover, you can take out the loan against the cash value when your child starts college. The insurer will lower the death benefit if the loan is not paid back. But you shouldn’t consider it as a drawback, especially if you intended to buy life insurance for college savings.
Benefits of Whole Life Insurance Savings — How You Can Transform It into Education Insurance to Pay College Expenses
Some of the top benefits of a whole life insurance savings plan are:
- If the policyholder who is responsible for paying all or some of the college costs of their child passes away before paying off all the amount, the policy death benefit will be available to cover some or all costs. The proceeds are not taxable hence making fee payment to college tax-free.
- If the policyholder is alive and needs access to their insurance policy to pay college fees, they can easily borrow from their cash value balance without proving their creditworthiness. Again, the proceeds are also tax-free here.
Concerns Related to the Future Education Costs With Life Insurance
The option of buying whole life insurance for college savings is a good idea, but just like every option, it comes with concerns that you must address and be aware of before moving forward. Let’s take a look at them now.
To benefit the child life insurance college fund through life insurance with a saving plan, you must be insurable. Individuals with health problems can’t acquire insurance, and if they do, the premiums are high, which makes the option less attractive.
You can’t just access the cash value funds whenever you need them. The insurance policy has to be in place for years before the funds accumulate and become accessible to you. Therefore, it‘s best to invest in life insurance with a saving plan as soon as you become parents, especially if you plan to send your child to college.
If you want to access the funds, you must borrow against the cash value balance. However, this loan will then accrue interest which, along with the amount borrowed, reduces the coverage amount payable when a death claim is made.
Mortality expense can lead to fewer funds invested in the cash value balance. Here policyholders need to understand that a big chunk of premiums from their life insurance policies is used to address the cost related to policy risk, such as the insurance risk of a death claim.
As using whole life insurance to fund college can be expensive, families should consult their insurance agent or financial advisor to discuss the policy limitations and concerns in-depth. This will help ensure and evaluate the return of a life insurance policy and whether or not it outweighs the cost. Depending on your situation, your financial advisor can help you decide whether life insurance to pay for college is a good option or other alternatives like a 529 plan are more beneficial.
About 529 Plans
This is yet another way to save for college. Before discussing the two best 529 plans for college savings, let’s first tell you what a 529 plan is.
Firstly, a 529 plan is an investment account. It offers tax benefits when you use it to pay for the educational expenses of a designated beneficiary. Hence, the funds can be used to pay for the college of your child. Secondly, with this plan, savings will have a minimal impact on financial aid eligibility.
The IRC section 529 and the tax-free status for qualified tuition programs impacted the development of college plans in the US. Currently, there are two 529 plans, and we’re going to talk about them now.
Education Savings Plans
An education savings 529 plan is similar to Roth 401K, where the after-tax contributions are invested in ETFs, mutual funds, or any other similar investments. The investments under your 529 plan grow on a tax-deferred basis. Hence, if you want to use the money for a qualified higher education expense, you can withdraw it tax-free.
Prepaid Tuition Plans
This 529 plan allows you to lock in tuition prices at today’s rates for a student who will attend college in the future. You have the option to make a lump-sum payment or a series of small installments every month.
Which 529 Plan to Opt For: Owned by a Parent or Grandparent?
The decisions related to the distribution and account ownership make all the difference when it comes to qualifying and maximizing your eligibility for the federal student financial aid on a need basis.
The assets held in parents’ accounts are considered when applying for Free Application for Federal Student Aid (FAFSA). The first $10,000 of parental assets are considered asset protection allowance. For those parents who save more than this allowance, a maximum of 5.64% of the assets are counted.
However, assets held by a 529 plan owned by a grandparent will have no effect on the student’s FAFSA. When grandparents withdraw the funds to pay for their grandchild’s college costs, it will be considered student income by FAFSA. In addition, student income is assessed at 50%. So, if a grandparent contributes $4,000 for college expenses, the student’s eligibility for aid will drop by $2,000.
Please note the higher your Expected Family Contribution (EFC), the less financial aid your child will receive. The best strategy to reduce the effect of grandparent support on FAFSA is to change the account owner (grandparent) to the parent or plan your 529 plan distribution carefully.
Is a 529 Plan Better Than a Savings Account?
If you’re wondering which option is better, a children’s savings account or a 529 plan, review the chart below. We have evaluated both options in a table format to help you understand the differences and determine which one is a better choice.
|Type of Investment||Some savings accounts earn interest on the savings while others don’t.||They are invested in bond mutual funds, money market accounts, and stocks.|
|Tax Benefits||None||Post-tax contributions are not deductible from federal income taxes. Plus, the growth of the funds in a 529 plan is tax-deferred.|
|Eligibility||Restricted eligibility, which depends on the family income level and place of living and the child’s age||Everybody is eligible for this plan.|
Can I Buy a Computer With 529 Funds?
When evaluating the 529 savings account pros and cons, many parents are concerned about whether the 529 funds can also cover other college-related expenses. For example, what if your child needs a computer or laptop for college? No need to worry because you can use the 529 funds to buy a computer. In fact, the 529 plan can cover the following:
- Room and board
- Technology items such as printers, software programs, and laptops
- Books and supplies
- K-12 Tuition
- Student loan repayment
Life Insurance vs 529 Plans
You may be wondering, “Is whole life insurance a good investment for a child? What about a 529 plan?” Let’s dig deeper to evaluate and compare these two options.
|Features||529 Plan||Life Insurance|
|Requirement||Everybody and anyone can open a 529 plan. There is no requirement based on health, age, income, or insurable interest.||Not everyone is eligible. To qualify, you must have good health.|
|Funds Available||The funds are accessible and available to the account holder immediately.||You will not be able to withdraw more money than you’ve already paid in premiums.|
|Tax Benefits||The 529 savings plan is tax-deferred.||It’s tax-free.|
|Obligation to Pay||The initial and additional contribution minimum varies by plan.
Plus, since there are no annual contribution limits, you can contribute as much as you want and start with even less than $1000.
|Premiums must be paid on a monthly or semi-annual basis.|
|Control of the Account||The owner has full control over the account at all times.||The life insurance company controls your account.|
Now let’s look at other possibly best college savings plans:
ETF vs 529
ETF is a popular way to save for college. It’s an abbreviation for exchange-traded funds. An ETF is similar to a mutual fund as it’s a basket of securities. However, unlike mutual funds, ETF customers can trade funds throughout the day. Some of the other benefits of ETFs include tax savings, trading flexibility, and risk management.
However, many benefits are lost when ETF is held in a 529 plan. While ETF clients can trade funds throughout the day, a 529 plan account owner can only make investment changes twice a year. Moreover, tax savings on an ETF become irrelevant when held with a 529 plan. This is because a 529 plan offers tax-free growth and withdrawals.
529 vs Coverdell
Coverdell ESA (Education Savings Account) is yet another tax-deferred way to save and pay for college. However, it’s different from a 529 plan.
Coverdell accounts have an annual limit contribution of $2,000.
There are practically no restrictions related to income level when making contributions with a 529 plan. But you may not be eligible to use Coverdell if the adjusted gross income is higher than $110,000 for an individual and $220,000 for a married couple.
Expenses vs Tuition
If you use a 529 plan for elementary and secondary school only, it’s limited to tuition. However, Coverdell ESA can also cover elementary or secondary school expenses.
Which Is a Better Investment to Pay for College?
Although there are many ways to save funds for college, the best investment is perhaps through a 529 plan. Saving for college with life insurance is a good idea, but it doesn’t offer all the great flexibility and advantages that a 529 plan has.
Here is why a 529 plan stands out:
Multiple Tax Benefits
A 529 plan account holder enjoys multiple tax benefits. For example, the earnings on your 529 plan are not counted under Federal tax. Not only that, your money in a 529 plan grows tax-free. Apart from federal tax benefits, you may also enjoy other state tax benefits, which vary by state.
Low Account Maintenance Fee
The fee associated with opening a 529 account is very low. Once you open an account, you will not be subjected to hefty annual fees to maintain it. In most states, the accounts are free, while some may charge $10–$35 annually. This is a very low fee compared to a 2% yearly fee on whole life insurance plans.
Easy Availability and Tax Incentives
One of the biggest and best advantages of a 529 plan is that you can open your account in any state, regardless of where you live. Some states also provide tax incentives on 529 plans. These are offered by Arizona, Minnesota, Montana, Pennsylvania, Arkansas, Missouri, and Kansas. Hence, it’s worth shopping around and comparing 529 plans in different states.
Contributions Made Easy
Through 529 plans, immediate and extended family members and other relatives can easily and conveniently help their loved ones manage college expenses. They can conveniently make contributions to 529 plans — periodically or occasionally, whichever is more suitable for them.
Strict 529 Policies
However, when comparing life insurance vs 529 for college savings, the 529 plan seems a good investment as long as you are 100% confident that your child will go to college. If you’re not, then we’d suggest life insurance.
This is because 529 plans are strict. The funds in a 529 account are available solely for qualified educational expenses. Hence, if you don’t use them for college funding, they will not be tax-deferred. You will owe taxes on the gains at the rate of the IRS charges. In addition, you will have to pay the penalty at a 10% rate.
In a nutshell, both life insurance for college savings and a 529 plan are good options for college savings. You can start out with a whole life insurance plan and use it to finance your child’s college education if they plan to go to college. If they don’t, you don’t have to worry about incurring a penalty and paying the price for not utilizing your college funds. This is perhaps the only drawback to a 529 plan. So, check out all the options to make an informed decision.
If I Get an Education Loan From My Life Insurance Policy, Are There Long-Term Implications?
Yes. Getting a loan from your life insurance policy will mean that the potential death benefit is likely to reduce until you pay back the education loan. Since your insurance provider uses the policy as collateral for the loan, they will add interest payments to the borrowed amount.
What Are the Four Benefits of a 529 College Savings Plan?
- You get federal tax benefits.
- The 529 plans are flexible and low maintenance.
- The plans have a high contribution capped limit.
- There is no age or income requirement.
Is IUL Good for College Savings?
Indexed Universal Life Insurance for college savings works just like a 529 plan. It has tax-deferred growth and tax-free distributions. However, it can be a good option if your sole purpose is not an educational expense. You can take out funds from IUL at any time for any purpose but using participating policy loans.
Why Is a 529 Plan a Bad Idea?
It‘s a bad idea when you are not confident if your child will go to college or if the stock market is volatile. The 529 plans are designed solely for educational purposes. Failure to utilize them for educational expenses may result in a penalty.
In the case of stock market volatility, parents of 0 to 10-year-olds can easily recoup any losses. However, this can be difficult for those with 11 to 16-year-old children, as the recovery time may be short. Depending on the risk tolerance, it’s best to switch from age-based options to aggressive stock options.
What Happens to 529 if the Stock Market Crashes?
When the stock market crashes, you can lose money on 529. That’s the time when people usually panic. However, the worst thing you can do is cash out since it will lock in losses and may cause you to miss the recovery. A much better approach is to increase your savings per month. That way, you will compensate for the losses.
What Is the Best Account to Save for College?
Both life insurance for college savings and a 529 plan may work for you. What plan you opt for really depends on your family’s unique financial considerations. What works for one may be a loss for another. Check out all the college savings plans carefully to find the one that best suits your needs.