Saving 4 College: Life Insurance vs 529 Plan

By on May 11, 2018

Your child is growing up fast and before you know it, they will be headed out of the nest and off to college. It may seem far off distant future or maybe the time is quickly approaching, either way, it’s time to start making a plan to help them pay for or finance their education. Apart from your average savings account or 529 savings plan, cash value life insurance offers parents a tax-deferred vehicle for funding all of your child’s college expenses. And as always, the sooner you start planning the better.

To qualify for financial aid, your child is responsible for earning good grades and being a successful student, and you will be responsible for starting and/or monitoring their college savings vehicle(s). Whichever investment vehicle you choose – savings, home equity loans, investment accounts, retirement accounts, annuities, life insurance and 529 plan – will have a huge impact on your taxes and retirement plans, as well as your child’s financial future.

Where you decide (as a family) to store your child’s college savings could impact his or her ability to attend college almost as much as grades and SAT scores. Money stored in the wrong account or tapped into at the wrong time can subtract from a student’s financial aid package.

If you are one of the several million families expecting to finance your child’s education, then it’s time to speak with your trusted financial advisor and discuss the benefits of using a cash value life insurance policy. Unlike borrowing from your home or starting a 529 savings plan, a life insurance policy is not counted towards a family’s financial aid contribution, has more flexibility to use for any expense and offers even better tax advantages.

Let’s examine the advantages and disadvantages of using permanent life insurance for college savings over the ever popular 529 savings plan…

529 College Savings Plan

A 529 college savings plan is administered by your state or educational institution with a special set of benefits, however, there are a number of restrictions involved.

Advantages of Opening a 529 College Savings Plan:

  • Money deposited grows tax-free and may be withdrawn for qualified college education expenses
  • Money (including growth) is not included in the estate of the plan owner(s) – parent(s), grandparent(s), etc.- for tax purposes
  • Plan owners may use the funds as an IRA if not used for education purposes (with penalties)
  • Plan owners can name a successor or contingent account owner in the event of their death or incapacitation

Disadvantages to Starting a 529 College Savings Plan:

  • Not all states offer tax breaks for deposits made by a plan owner – some states only offer breaks for plans associated with their state or public university system
  • Taxes and penalties will be levied if funds are withdrawn but not used for a student’s qualified college expenses
  • Invested funds are subject to market risk and are not guaranteed to keep up with the rate of inflation or to grow fast enough to cover growing college tuitions costs
  • There are limits to how much money plan owners can deposit: up to $60,000 the first year and limited by the $12,000 gift tax each year after
  • In the event of the plan owner’s death, successor account owners have the right to withdraw all account assets leaving your student without funds

Cash Value Life Insurance

A loan of cash from a well-funded life insurance policy can be a great alternative way to fund your child’s college if the policyholders need long-term life insurance and plan to hold the policies for life

There are two types of permanent life insurance which offer a cash savings option: whole and universal life insurance. These savings vehicles allow policyholders to withdraw a certain amount of the cash value as a loan without paying taxes or a penalty.

Pay for College from Cash Value Life Insurance

  • The value of a permanent life insurance policy is not reported as a parent assets when a child applies for college financial aid or loans
  • Cash value grows tax-deferred and may be tapped via a loan tax-free (within limits) for college
  • You may maximize your rate of return by purchasing a policy with a low death benefit and contribute the maximum allowance
  • Life insurance savings can be used for anyexpense – college tuition, books and student housing, a down payment on a house, to start a business (or for retirement income in the future) – throughout the policy owner’s life
  • Life insurance is a “self-completing” plan which pays out an income tax-free death benefit so your child doesn’t come up short when it’s time to pay for school

Keep in Mind When Using Life Insurance for College Savings

  • Taking out loans against a life insurance policy does reduce the death benefit
  • Time should not be an issue. To keep ahead of inflation and avoid costly fees or other expenses, give any insurance policy 10 to 12 years to see optimal rates of return
  • Cashing out a life insurance policy completely will count as income and may reduce your student’s financial aid eligibility
  • There are often administration and advisory costs associated with life insurance policies – consider insuring the student to lower overall costs

Cash value life insurance can be a great alternative vehicle for middle income families who already expect to take out some sort of loan for their child’s education. With a life insurance policy you will benefit from low interest rates, steady growth rates, leverage and options for giving money to your child tax-free. And in the end, you should still have a viable cash value and death benefit waiting for you in retirement or to be passed onto your benefactors.

Financing College with Life Insurance or a 529 Plan

Can a life insurance investment outperform a 529 college savings plan? In the right financial situation, using permanent life insurance for college savings may be justified over other investment vehicles such as a 529 plan. Before enrolling in a life insurance policy or 529 college savings plan, comparison shop and talk numbers with your trusted financial advisor to see whether the no-risk returns of a life insurance plan outweigh the costs and lost tax deduction of a 529 plan. Start planning now so the next generation is prepared to be financially successful when they grow up and start families of their own.

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About Amanda Jensen

FSN college advice columnist - Amanda gives parents and students knowledgeable advice on college planning, tuition financing and scholarships. With up to date and accessible information covering everything from personal finances to federal government policies, she is determined to make the college experience a painless one for all party's involved. You can find Amanda on !

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