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College Funding Strategies

529 Plan or Cash Value Life Insurance?

I remember it like it was yesterday. There I was, a 16-year-old kid, finishing up my junior year in high school after yet another amazing season on the varsity soccer team as the MVP and leading goal scorer. I was one of the best players in the southeastern US and looking forward to finishing up my high school career and moving on to college at one of the best programs in the country. After all, I had a 3.4 GPA, near 1200 on my SAT and enough talent to play on any team in the country.

So what’s the problem you ask?

You see, I didn’t care if I got a scholarship, I didn’t care if I started my freshman year on the team, I didn’t care about anything except for playing for the best team that would have me. Then came reality in the form of a conversation with my father, that I know must have been extremely difficult for him to have with me. One evening, after the coach from a local university in Georgia came to visit my parent and I, my father sat me down and told me how proud he and my mother were. He told me how excited they were that I was going on to play college soccer and how they would help support me in any way possible.  Then came the BUT….

They hadn’t ever thought about their kids going to college because nobody in our family had ever been.  They hadn’t saved money to help me and they weren’t in a place financially to pay for it out of their current income. It was all they could do to handle their current expenses, much less take on tuition, books, room and board, etc. for a college kid. So he told me to go to the school I could “afford to pay for”. Talk about a buzz kill for teenager. I ended up going to that local university, staying in Georgia because the Hope Scholarship (a state sponsored academic scholarship for GA residents) covered my tuition and books.  My soccer scholarship covered everything else and I graduated 4 years later, right on time, with a BA in Marketing and no debt.

Now as the father of a large and growing family, I know exactly what it’s like to try and balance the demands of today with financial needs of the future, including the massive looming liabilities of a college education.

For most Americans, a college education has become the standard for getting a better job, but the price tag for higher education has risen faster than other industry in the US, up nearly 1,100% in the past couple of decades. For the 2014-2015 academic year, the average public school tuition is now over $20,000 per year, according to the College Board. Whereas private school tuitions are well over $30,000, making a college degree a six figure investment that can take a lifetime to pay back if not planned for and funded properly.

It is imperative that lower and middle class families need a long-term savings plan if they hope to avoid a mountain of student loan debt. About 30% of households, the vehicle of choice is a tax advantaged 529 plan.

A 529 plan are similar to retirement plans like a Roth 401K or Roth IRA, except for college expenses instead of retirement income. You invest in mutual funds.  Those funds are subject to market risk and fluctuations.  You can make (or lose) money and the earnings grow tax-free until you make a withdrawal. As long as you use the money for certain education related expenses, you will not be charged capital gains tax on the funds you use for education related expenses. Some states also offer a tax deduction or credit for contributions to their plan, which only adds to their appeal.

While the 529 is in some ways is the standard when it comes to saving for college, it’s not the only option that provides tax benefits. Another strategy is to use a permanent life insurance policy, which, unlike term coverage, includes a tax deferred savings component. If given enough time for the plan’s cash-value to grow, parents can draw on these funds tax free to pay tuition and related expenses.

So how does permanent life insurance works as a college savings vehicle? When you pay the premiums, a portion goes towards the death benefit, but another part is diverted to a separate cash-value account where it can grow tax deferred without the typical risk associated with the stock market. These funds can even be accessed on a tax free basis through policy loans that don’t have to be paid back. Since it’s technically a loan, it isn’t taxed and the death benefit is tax free, so the loan is repaid at death.

There are a few types of life insurance policies that can accumulate cash value that can be accessed on a tax free basis for college. In simple terms, whole life insurance pays a guaranteed amount, although it may pay more if the investments perform well. index universal life is tied to stock market performance but is not actual “invested” in the market. You are guaranteed to never lose money, so your “floor” is 0%, but you can make up to a “cap” which is usually 10% to 12%. Most policyholders can expect anywhere from a 3% to 8% return after the first several years depending on the policy terms and investment performance.

Other types of coverage, such as variable life insurance, give policyholders a degree of control over their investment. In this case, you select the subaccounts – essentially mutual funds – that you want attached to your policy, and your account’s annual return is pegged to the performance of these underlying investments. So the potential reward is greater, but there’s a risk that your balance could actually recede in a given year if the market takes a plunge.

When it’s time for your son or daughter to start college, you can take out a loan against your cash balance. The insurer will reduce your death benefit if you don’t pay back the loan, but that’s not necessarily a worry for those who primarily use the policy as a college savings plan. In most cases, the principal portions of these loans are tax-free.

When contrasted with a 529 plan, life insurance has a couple of nice benefits going for it. One is flexibility. Suppose your child, for whatever reason, ends up not going to college. Any earnings in your 529 account, although not your contributions, are now subject to ordinary income tax and a penalty if you don't use them to pay for education costs. There are some plans that allow the beneficiary in a lower tax bracket to withdraw the funds, but it’s still a significant tax hit that life insurance owners don’t have to face.

The other big advantage of insurance is that it’s not included in the calculation for the students qualification for financial aid. Conversely, money in a 529 account, whether the parent or child is the owner, counts as a parental asset. And up to 5.64% of these assets are included in the applicant’s Expected Family Contribution.

Last but certainly not least, life insurance can be used to address a whole host of other financial issues that your child will face throughout their lifetime. A properly structured plan including life insurance on a young child can provide a lifetime of flexibility and financial options. Not just the death benefit which their future family will need, but access to funds for college, marriage, home purchase, start a business, emergency funds, medical bills and even retirement income.

CONTACT US today to see which college funding strategy best fits your situation, needs and budget. Better yet, let us show you how to turn your college funding strategy into a lifetime of financial support and options for your growing family.