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May 26, 2021·

Should You Use Life Insurance for College Planning?

Higher education comes with high prices, so it's important for parents to be well prepared when it's time for their children to go off to college. For many, that means getting a 529 plan. But is that the right answer, or would you be better off using life insurance when it comes to college planning?

How much does college cost

They grow up so fast, don’t they? One minute you’re filled with joy as your baby takes their first steps; the next, you’re looking at their college bill and questioning the importance of higher education while hoping your child becomes a TikTok star.

That’s because the average annual cost of going to college is more than $35,000, with prices even going as high as $50,000 in some colleges. Overall, the cost has tripled in more than 20 years, with an annual growth rate of 6.8 percent. So if you have children approaching college age, you can expect to pay even more.

And if you’ve got young kids now, then you might be in for a bit of a shock when they go on to higher education further down the line. It’s safe to say that college isn’t cheap, and the cost can be a significant financial burden if you’re not prepared for it.

Average cost of tuition breakdown:

Average in-state student attending a public four-year institution: $25,615 for one academic year Average cost of in-state tuition alone: $9,580 Out-of-state tuition averages $27,437 Average traditional private university student spend: $53,949 per academic year, of which $37,200 is on tuition and fees

Factoring in all of these costs and taking into account student loan interest, as well as lost income, the total cost of a bachelor's degree may well exceed $400,000. It's not exactly pocket change.

How does loss of income work?

It will be hard for your child to maintain an income while studying unless they have a part-time job. Therefore, one of the largest expenses related to enrolling in college could very well be the loss of income they spend studying instead of working.

For parents, that means potentially supporting their child financially while they study. Those costs can be just as daunting as tuition fees and other financials related to attending college.

Considering all the above, you can make a fairly educated guess that you'll need to fork out a fair amount of money to send your child into higher education. Fortunately, there are options to help you prepare.

What are my options for college planning?

Unless you’re planning on winning the lotto, one of the best ways to pay for your child’s college is by establishing an early financial savings vehicle. Preparing in advance is always the best tonic for safeguarding your financial future.

One of the most common ways to pay for higher education is with a 529 college savings plan. It's available in all 50 states and acts as a way to save for college through a tax-deferred scheme.

Tell me more about this 529 plan

A 529 plan is an investment account offering tax breaks when the money is used for qualified education expenses, such as tuition, fees, books, and other important college supplies. It works much in the same way as a Roth IRA; only it's for the purpose of education instead of retirement.

Any contribution you make to a 529 plan is made after-tax (with the exception of some states). The money in a 529 plan grows tax-free and can be withdrawn free of tax when used to pay for education.

Should you wish to use it for any other reason, however, you will need to pay taxes and a penalty of 10 percent. But of course, if it’s solely for college planning, then you shouldn’t need to worry about tax and penalties.

**That sounds great. Where do I sign up? **

Whoa there. Sure, a 529 plan can help you save for your child's education, but let's not get carried away. It's not all rosy when it comes to using a 529 plan. That's because a 529 could possibly impact your child's ability to go to certain colleges as much as grades and standardized test scores.

A 529 plan could actually harm the student’s chance of tapping into other sources of financial aid. Also, if a 529 owner rolls over into another state’s 529 plan, any state income tax deductions and credits claimed may be subject to recapture. This could see the earnings portion of the outbound rollover added back to the state taxable income.

Another aspect to consider is that 529 funds aren’t very flexible and can only be used for educational purposes. So if for any reason your child doesn’t need the funds for college, you won’t be able to tap into it for, say, a down payment on a house or for extra cash to kick start a business. They’ll have to either use it for higher education or wait until your grandchildren are ready for college again.

You also need to be wary when shopping for a plan. Direct-sold 529 plans are less expensive than advisor-sold ones, and the more you pay into fees, the less money they cover for college. Therefore, it’s important to research your options before committing to a 529 plan.

Using life insurance for college planning

Another option for college planning comes in the form of life insurance. Now, you might think that life insurance is something designed to pay out after you’ve passed away–and you’d be right. But it also has plenty of benefits while you’re still alive– for you and your children–if you opt for permanent life insurance cover.

One of those handy benefits is that it can pay for your child’s college and has fewer restrictions on distributions. Life insurance for college planning also offers a place for families to keep funds from the federal financial aid methodology. And if you’re wondering what that is, it’s the formula used by the federal government to calculate your Expected Family Contribution (EFC) for a Federal Pell Grant, campus-based programs, and Federal Subsidized Direct Loan Programs. Having a 529 plan could disrupt what your child is eligible for as it’s taken into account, but life insurance isn’t included for when the government does its checks .

A percentage of each payment you make into a permanent life insurance policy goes towards a savings account, dubbed “cash value”, that grows over time. Your cash value grows on top of your death benefit, so accessing it doesn’t affect what your beneficiaries receive after you pass. When you’re ready to use your accumulated cash value, you can withdraw your principal and “loan out” your investment growth (typically at 0% interest rate), and you can use the money to cover college fees for your children.

How exactly does that work? Essentially you’re growing cash on top of your death benefit and you’re simply taking out that growth early (before you pass). Thus, you’re loaning from yourself at a 0% loan interest rate and it’s all tax-free. Read more about it here.

Using life insurance to cover college costs is somewhat unconventional, but that's mostly because not enough people know about its benefits. More than half of Americans surveyed were unaware or didn't believe that permanent life insurance had a cash value, one that can potentially be used to pay for college.

One of the key differences between permanent life insurance and a 529 plan is that savings inside a life insurance policy can be used flexibly, meaning you can use it for college, a down payment, or keep saving up until retirement for your kids if you wish. You can also transfer the ownership of the policy to your kids later in life so they can take over payments and keep saving for their own financial future.

Let's look at the benefits, as well as drawbacks of permanent life insurance.

Permanent life insurance pros and cons

As with any investment vehicle, there are both pros and cons. Whether permanent life insurance is a good savings plan for your kids depends on your personal situation. But if you’re thinking about using it to pay for college planning in the future, it could just come in handy. Plus, it has plenty of other advantages.

Pros of permanent life insurance

  • Financial protection for your family – you’re able to lock in a very low rate that your kids can keep for the rest of their lives by helping them get a policy at a young age. That means they can protect their family for the rest of their lives from income, mortgage, or college tuition fees
  • Grows in value over time – having more financial power later in life can really come in handy, and you can benefit from the cash value you’ve accumulated in your policy by withdrawing it or taking it out in the form of a loan to help you pay for things like, you guessed it, college fees
  • Flexible investment options – you can choose a policy that has high historical market returns, or one that can still grow up to 12% but isn't subject to market volatility
  • Tax-free savings and death benefit – the best part? Your investment growth and death benefit are all tax-free

Cons of permanent life insurance

Financial aid

As well as using investment vehicles like permanent life insurance and 529 plans, financial aid may also be beneficial for your child. Essentially, financial aid is any form of funding that helps pay for college. It includes aspects like scholarships, grants, loans, and work-study programs.

There are two primary ways to qualify for financial aid: through financial need or merit. Financial need requires the federal government to calculate your child's needs, which they do so based on the information you provide FAFSA.

With merit-based aid, colleges and private organizations award scholarships to students who have academic, athletic, or artistic talent. Until the FAFSA form is filled out, you won't know what type of aid your child will be eligible for.

However, because financial aid lowers with the more assets you have, you could find that your child doesn’t receive a significant amount of help. One way to counter this involves moving your money into a high interest savings account like permanent life insurance. Cash-value life insurance isn’t included in the financial aid forms. Therefore, it can be beneficial when you’re applying for financial aid.

What if my child ends up not needing the funds for college?

What if your child ends up being a high achiever and gets a full ride to college? Or perhaps they’ll decide to start a business instead? Flexibility on using your cash for something else outside of college can be extremely helpful as we never know what may be the case a decade or two from now.

Aside from college planning, there are other benefits to permanent life insurance which can help you safeguard your future. We’ve already touched on the cash-value aspect, and this can essentially be used for anything you want once you’ve accumulated enough value. Having the cash value can be particularly beneficial if you’re planning for retirement, as you will have access to more wealth later in life.

Of course, all of this is tax-free. So you can grow wealth and access tax-free returns. We can’t state enough how important this is when planning for your financial future, especially as it provides a death benefit–something you don’t get with retirement accounts like Roth IRAs and Roth 401ks.

That death benefit may even be accessible before you die, with between 25 percent and 100 percent available to you in the event of a health emergency, like a heart attack, invasive cancer, stroke, or end-stage renal failure.

Its lifetime coverage also means you’re always covered. This is particularly helpful if you have people who depend on you financially, as it will set them up well should the worse happen to you.

So getting permanent life insurance can help with your college planning, as well as other aspects of your future like retirement and protecting your family if the worst happens.

In conclusion: another option for college planning

There are never any drawbacks when it comes to planning for the future, and using permanent life insurance to pay – or supplement – your child’s fees can lift a financial weight off your head while putting them on the path to higher education. Plus, you get all the other benefits that aren’t included with 529 plans and other investment vehicles. That’s why permanent life insurance is certainly worth your consideration when it comes to paying for your child’s college.

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