Whole life insurance: a simplified college savings plan
By Jason Lampa MBA
College Savings Bank
Using life insurance as a financial vehicle to pay for a child's college education provides significant tax sheltering value and also provides you with considerable flexibility.
During the past two years, I have come to appreciate the importance of life insurance in the financial planning process. The investment management industry often views those in the insurance industry as a less sophisticated nuisance with whom they compete. Having experience in both industries, it seems to me that insurance allows the financial professional greater flexibility to provide solutions to their clients.
An example of this can be seen in the college planning process. Most often, parents anticipate sending their children to college sometime in the future, but fail to come up with a plan to meet this financial obligation. It is imperative, in my opinion, that parents are provided with a simple solution that can be implemented without concerning themselves with the performance of the stock market.
Using life insurance as a financial vehicle to pay for a child's college education provides significant tax sheltering value and also provides you with considerable flexibility. We will be discussing how this works and reviewing several strategies and key points regarding using a whole life insurance policy to pay for those tuition costs.
When a life insurance policy is created, there are three parties to the contract: the insured, the owner of the policy and the beneficiary. When a child is born, the parents will generally take out a new life insurance policy on the child. Assuming that the child is healthy, the parents are able to take out a very large insurance policy for a relatively low premium cost.
The child will be the named insured, the parents are the owners of the policy and in most instances, the parents will name themselves as the beneficiaries of the policy, too. As the parents make their monthly premium payments, the whole life policies will automatically allocate a portion of the premiums to the policy's cash value, and the cash value portion of the policy grows completely tax free. When the child is ready to go to college, the policy can be canceled and the cash can be withdrawn to pay for college tax free (typically saving you 20 percent or more on each dollar), or the parents can keep the policy intact and borrow the cash value at significantly advantaged interest rates.
Establishing a whole life insurance policy may also provide peace of mind. If the parent passes away, the life insurance policy payout will cover the cost of your child's college education. If the parent is alive when the child begins college, then the cash value accumulated by the policy is available to pay for college tuition (remember that the cash in the whole life policy accumulates tax-free) or, again, you can take out very low interest loans against the value of the whole life policy to help pay for high tuition bills.
One additional key point to remember when applying for student aid is that it is not a requirement to include any accumulated cash value from of a whole life policy in the overall disclosure of assets. This increases the probability of obtaining grants or low-cost student loans to help pay for college. Finally, let's look at the opportunity cost that traditional college tuition savings programs present. Many people are faced with the choice of funding their retirement program or funding their child's college tuition account. It is a difficult situation when you have to choose between committing X amount of dollars per month to retirement or committing X amount of dollars per month to a child's college savings plan.
More than likely, investing into both is going to make it difficult to achieve a savings goals in either account. This is the opportunity cost. Whatever dollars you allocate to one account will not be available for use in the other. Using life insurance helps to tighten up a financial wellness plan, as it allows you to use your monthly life insurance premium towards your child's college tuition, effectively freeing up dollars to contribute to a retirement fund.
Using life insurance to pay for the cost of a child's college tuition, or at least as a part of the overall strategy to pay for college tuition expenses, can be a great way to leverage tax savings at the same time that it is protecting a family's overall long-term financial situation through life insurance. The policy owner has complete control of of the whole life vehicle, as it can be cancelled or modified at any point in time.
The policies allow for the use of tax-free funds to pay for college tuition, thereby maximizing the value of each dollar. It is also possible to couple a whole life policy savings strategy and a 529 college savings plan or to combine it with a more traditional savings account approach.
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