First some facts…average annual cost to send your kid to a private university this year was $36,993. The same for an in-state public university was $16,140. These figures represent an average increase of 6.4% over the past year. College costs generally increase by a factor of three over any 17-year period. There you have it.
Armed with these facts and sensing the plight of “helpless” parents, enters the insurance agent trying to sell them a cash value life insurance policy (traditional whole-life, universal-life or variable-life) as a means to sock money away for college. Listing down some of the “benefits” of this strategy, the insurance agent almost convinces you with a pitch which goes something like this…
Pitch No. 1 – Money saved in a cash-value life insurance policy is not taken into consideration when applying for financial aid
So does the money saved in retirement plans, home equity in a private residence (not rental properties), annuities (don’t do this either) and value of a small business owned and controlled by the family. The federal government expects parents and students to contribute a percentage of their income and assets toward the cost of college each year. This is known as the expected family contribution (EFC) amount. Other factors such as family size and the number of family members in college at the same time are also considered when applying for financial aid.
Parents applying for financial aid enjoy the benefit of an asset allowance that allows them to shield non-retirement money from consideration for financial aid.
An example should make it easier to see how this allowance works. Let’s assume that a family has $100,000 in non-retirement assets, including $30,000 in a 529 savings plan, and the oldest parent is 50. The family would get to shield $46,600 which would leave $53,400 unprotected. In calculating the family’s financial need, the federal financial aid formula does not expect the parents to sink all of that money into college. The parental contribution rate for the remaining asset is only assessed at 5.46%. When you do the math, the child’s eligibility for need-based aid would only drop by $2,915 even though the family had $100,000 in the bank.
This is chump-change compared to the expenses you will incur as a parent when investing in these life-insurance products. Start saving in these policies when your child is born and the real cash value accrual does not start till he is ten years old. Link attached to an article we wrote highlighting the long-term under-performance of these products Buying Whole Life Insurance…Don’t Do It.
And the other big factor is your family’s adjusted gross income or AGI. A high AGI could disqualify your child from receiving any aid even if your family savings are non-existent.
Pitch No. 2 – The cash value in life insurance policies can be borrowed at any time to pay for college
The first assumption is that you will have a cash value amount large enough to make a dent in college expenses. And then there are interest expenses. Exactly like a conventional loan, you’ll be charged interest ranging anywhere from 5% to 9% on the loan. Unpaid interest will be added to your loan amount and will be subject to compounding. That’s right – you’ll be paying interest on your interest. And that interest has to be paid – either out of your pocket or borrowing it from your policy. It’s exactly like borrowing on your home equity line. Just run an illustration of that and see what happens to your home equity. And the tax consequences of not paying interest out of your pocket and letting the remaining cash value in the policy to pay the interest are so complex that you don’t even want to go there.
Pitch No. 3 – The best one, the cash value in the life insurance policy grows tax-deferred
Alright, this pitch is so lame that it is actually funny. Tax-deferred in a life insurance policy versus tax-free in a qualified college savings vehicle like a 529 plan. In my book, tax free beats tax deferred seven days a week. Worse still, consider this – if you can’t pay the premiums on a life insurance policy, the policy lapses and you’re wiped out. There’s no money there to tap for college. With a 529 plan, however, if you hit a rough patch and can’t contribute any longer, the contributions you’ve made to date remain to grow and be spent tax free at the time of college.
Unless you really hate your wallet, don’t buy cash value life insurance policy – be it whole, universal or variable. And buying life insurance to pay for college, NEVER.
Instead, open a 529 plan and rest easy. Step-by-step instructions can be found in the attached link Third Best Way To Save For College. Third best? So there are two better ways, you ask? Sure there are. Follow the links below.
And a link to decide whether you should even save for college or are there other, higher priorities To Save Or Not To Save For College.
Image credit – Gratisography