Recently a friend asked me about a strategy proposed to her by a financial adviser. The adviser was recommending that she and her husband invest their children’s college savings in a life insurance policy. Here were the benefits as given by the adviser:
- The money grows risk free.
- It is life insurance the children can keep for the rest of their lives.
- The money isn’t counted as family assets for financial aid purposes.
On the surface these seem like good ideas. Saving for college in a life insurance policy has been a strategy promoted for ages. In fact, Gerber Life has promoted these policies on national TV for years. However, life insurance is probably the least effective way to save for college there is. If someone recommends a life insurance policy for your college savings, run.
The policies promoted are known as permanent or whole life policies. As long as you pay the premium you will have life insurance for as long as you live and a guaranteed death benefit when you die. A portion of your premium pays for the death benefit and a portion earns interest which builds up a cash value. Over many years, the cash value grows, and it and the death benefit become one and the same.
The money does grow risk free at a low interest rate. The cash value will not decline, unless you withdraw it or stop paying the premiums, and it will grow slowly over time. However, there are many college savings options that offer a greater return and much lower expenses. The death benefit is a big expense that cuts into your college savings, as does the hefty commission the adviser earns for selling you the policy.
Many state 529 plans offer age based investment options that gear their investment strategy to the remaining time until your child starts college. Though not guaranteed, these options offer sound strategies that can more efficiently grow your college savings.
As a permanent life insurance policy, your children can keep the policy at the same premium rate for their lifetimes. However, to withdraw the cash value to pay for college, they will either need to take a withdrawal, which is a taxable event, or borrow from the policy. Any amount you withdraw or borrow reduces the death benefit, and withdrawals can be subject to a fee called a surrender charge.
Children don’t need life insurance. You only need life insurance if there is someone depending on your income, and that is not the case for anyone until they have a spouse or children of their own. Your children can buy their own, much cheaper, term life policy when they get married.
Life insurance is not included in family assets for purposes of determining eligibility for financial aid, whereas money saved in a 529, or other college savings plan is. However, the first $20,000 in savings is exempt from the Expected Family Contribution (EFC) and the EFC is capped at 5.64 percent of parental assets. You can save quite a bit before your child’s eligibility for financial aid is impacted.
When your children are young, it is important for you to have life insurance on yourself. You’ll want your children to have all the advantages you would have provided if something happens to you. However your children don’t need their own life insurance, and it is an expensive and inefficient way to save for college. If you have money to put toward your children’s education, check out your state’s 529 college savings plan instead.