There are several vehicles a family may choose to save money for college in. One that has gained increasing traction recently is a universal or whole life insurance policy. In this, a whole life insurance policy is purchased and extra contributions are made to the policy. This methodology is as viable as any, but there are some important pros and cons to consider when comparing it to other college savings options.
Let’s start with the advantages. The first and most obvious is the child now has a life insurance policy though it might not be likely the child produces an income for the family that needs to be protected by life insurance. The next huge advantage over a 529 plan in particular is flexibility. Withdrawals from 529 plans are limited to use on “qualified educational expenses” such as tuition, room and board, and fees. So if your student’s car broke down while away a college and they faced a $500 repair job, a 529 plan couldn’t be used whereas funds from a life insurance policy could. Insurance policies also guard against risk. 529 plans are usually tied to the stock market so down years could devastate college savings. Life insurance policies have a stable rate of return that can inch up with time. Of course, with this you could be missing out on the upside of the boom years in the market. Lastly, life insurance policies won’t count against financial aid the way a 529 plan does. For every dollar saved in a 529 plan, 5.64 cents will be deducted from potential federal student aid. This is not true of insurance policies.
Okay, now let’s look at the downside of this savings vehicle. The costs associated with life insurance policies are usually going to be higher. 529 plans typically have low administration fees. Many states also offer state income test tax deductions for contributions to 529 plans which can be quite valuable depending on your state of residence. In a life insurance policy, you’re paying for the coverage provided by the policy which is rarely truly needed on a child. There’s also some other associated fees with the policy. Next, making withdrawals from a life insurance policy is complicated. Most financial advisors will tell you withdrawals for college should be taken as a loan from the policy and therefore must be repaid with interest. There are a lot of other complex tax implications here too. Finally, parents should remember a whole life insurance policy is going to get sold to you, probably by an agent, and buyers should beware. You’re not going to find the same kind of sales pitch coming from something like a 529 plan so you need to be cautious that an insurance agent is working in your best interest and not theirs.
Personally, the 529 plan is the direction I’ve chosen for my children but I have some financially savvy friends who are utilizing life insurance policies for their college savings. These aren’t even the only ways to save for college and other strategies have their own benefits and downsides. Whatever path you choose, just make sure you do your homework first and remember that any attempt at putting money aside for college is a smart move.
