Is there Another Way to Pay for College?

There are generally 5 ways to pay for college: scholarships, grants, student loans, work-study, and self-pay. We certainly want our children to excel in both academics and sports but the truth is there are a limited number of scholarships available; all children will not qualify. There are various types of grants and like scholarships, most of them do not need to be repaid. The one thing to know about a grant is that it is awarded based on financial need. Student loans are too available in my opinion but if you don’t receive a scholarship or a grant and cannot afford to self-pay, this may be your only option. Student loans can be federal or private loans. Most federal student loans don’t require a credit check which makes them more accessible. Currently, the minimum credit score for most private student loans is 670. Interest rates are generally low, but student loan debt cannot be discharged in bankruptcy. So, if you plan on ditching the lender after graduation you might want to think again. Student loan debt can and will haunt your credit score making it more expensive and sometimes impossible to finance a home, or car, or even purchase a cell phone or afford car insurance. In my professional opinion, student loans are dangerous and should be avoided. This means as parents and grandparents of potential college students, we need to be proactive and look for alternatives early.

You might think saving for college is a no-brainer but the truth is how and where you save money matters as you could potentially disqualify your child from student aid they might otherwise receive. I know how frustrating this sounds but it is our responsibility to educate ourselves and make the best decision for our children. With that said, everything you read on the internet is not accurate. Unfortunately, some authors are simply ignorant (defined as lacking knowledge, information, or awareness about a particular thing) while others have a personal agenda and fail to provide an unbiased opinion. Let’s look at the article by Christina Couch dated June 7, 2011, entitled “Life Insurance or 529 Plans for College Savings”.

In her article, Ms. Couch states that 529 plans are preferred by many families and financial advisors, offer federal and sometimes state tax benefits, and have less impact on a student’s financial aid package than saving in a traditional checking or savings account. She adds, however, that if you have a sizable 529 Plan balance it could prevent the student from qualifying for other sources of financial aid. She claims this dilemma has families examining other options like cash value life insurance policies which don’t offer state tax incentives, have fewer restrictions on distributions, and offer a place for families to shelter funds from the financial aid formula.

She begins by comparing the flexibility of both plans.

Round 1: Flexibility

According to the Internal Revenue Service, money in a 529 college savings plan can only be used for “qualified education expenses” including tuition, fees, books, and room and board at an accredited U.S. school. Should your child opt out of college, choose a foreign or unaccredited school, or receive a full scholarship, you can transfer 529 funds to another beneficiary or pull the funds out and pay income tax on the withdrawal. You may also have to back taxes if you’ve taken state tax deductions over the years as well as a 10 percent penalty on earnings.

“With life insurance, it doesn’t matter how you use the cash,” says Jim Van Meter, founder and president of The College Planning and Funding Advisor in Reno, Nev. A student can use life insurance savings for college, a down payment on a house, to start a business or for retirement, he says.

I find it interesting she chose to quote another advisor here. It leads me to believe she is not confident in her own knowledge of the various types of permanent life insurance and its many applications. Nonetheless, I agree with Mr. Van Meter. When it comes to flexibility, permanent life insurance wins over 529 plans. However, I must point out that there are various types of permanent life insurance and only one type is superior when it comes to saving for college. Keep reading…

Round 2: Risk

Section 529 college savings plans fluctuate with the market. Whole and universal insurance policies frequently provide guaranteed returns if time is on your side, says Myron Feinberg, a Certified Financial Planner and founder of the College Aid Specialist in Commack, N.Y.

“In the first two years of a life insurance policy you’re getting a minimal of rate of return because (insurance providers) are pulling out the costs,” says Feinberg. “After 10 or 12 years, you will see a rate of return of 4 (percent) to 5 percent.”

Guaranteed returns can cap your earnings. Should the market generate returns above the fixed rate on your policy, life insurance holders may not earn any additional cash — whether you can depends on your insurance provider and policy.

“The thing about a permanent life insurance policy is that you want to put as much money in as the government will allow you,” says Jim Kuhner, owner and certified college planning specialist at College Selection Strategy in Keller, Texas.

Unlike 529 plans, some life insurance policies use a tiered system when doling out returns. The more you invest, the better your return rate. To maximize earnings, Kuhner advises families to purchase a policy with a low death benefit and to contribute the maximum allowance.

We have lots to unpack in this comparison. Again, Ms. Couch uses quotes from Myron Feinberg about Whole and Universal Insurance policies claiming there is a minimal rate of return in the first two years and only after 10-12 years will you see a 4-5% rate of return. A quote such as this is concerning at best. My first question for Mr. Feinberg is which type of Universal Insurance policy is he referring to here? You see, there are actually 3 different types: Universal Life (UL), Variable Universal Life (VUL), and Indexed Universal Life (IUL). Each is very different from the other. UL pays a fixed rate. VUL is invested into the stock market and thus pays a variable rate which includes posting losses when the market goes down. IUL allows you to make money when the index you are tracking goes up and protects your balance from any loss when that index goes down. Regardless of which type Mr. Feinberg is referring to, I can’t agree with his statement. I will say that of the 3 types of universal life policies available today, IUL would be the best option to accumulate cash with no risk of losing your savings to the wilds of the stock market. Never having to recover a loss before you can make more money should be very attractive to you.

Ms. Couch includes a quote from Jim Kuhner about putting as much money into a permanent life insurance policy as the government will allow. Hang on a minute. There are 4 basic types of permanent life insurance: Whole life, UL, VUL, and IUL. Which one is he referring to here? I simply cannot recommend whole life insurance policies as a college savings alternative. This is the most expensive type of permanent life insurance available with limited opportunity for growth. You already know how I feel about the other 3 types of permanent life insurance. One limits your earnings, one exposes you to stock market losses, and the other offers upside potential with downside protection. I want the one that protects me from stock market losses and you should too. I’m not sure what Mr. Kuhner is referring to by a “tiered system when doling out returns”. An Indexed Universal Life Insurance policy (IUL) applies an interest rate credit to your entire balance whether it is $1 or $100,000. Finally, if you use an IUL policy to save for college, the death benefit will be determined by the amount of money you need to save and how much time you have to reach your goal. I cannot emphasize enough how important it is to work with a seasoned life insurance professional when designing Indexed Universal Life Insurance policies. Keep reading.

Round 3: Financial Aid

One of the major advantages of using a cash value policy for college savings is that money in an insurance plan won’t reduce your financial aid. Money in a 529 college savings plan can subtract up to 5.6 cents in aid for every dollar stored in the account, but cash value policies are sheltered from the federal financial aid formula, according to the Department of Education.

“If families take money out of a life insurance policy for college, they need to do that as a loan,” says Van Meter.

Van Meter also says that taking a loan against a life insurance policy won’t count against your financial aid but will reduce your death benefit. Cashing a policy out entirely will count as income and can reduce your aid package by up to 47 percent and could incur surrender charges.

Families with low assets are already protected from losing federal financial aid dollars. According to the Department of Education, families can hold up to $74,000 in assets — including real estate outside the primary home, stock market investments, savings accounts, and college saving vehicles — without impacting their federal aid. Exactly how much depends on the age of the oldest parent.

Here Ms. Couch talks about using “a cash value policy” for college savings. As a consumer, I am guessing you may be getting confused with the terminology so let me clarify something for you. All permanent life insurance policies including Whole Life, Universal Life, Variable Universal Life, and Indexed Universal Life are cash-value policies. It’s true that the cash value of a permanent life insurance policy will not impact the federal financial aid formula which is a good thing. As a general rule, accessing the cash value of a permanent life insurance policy via a loan is the best option. However, a good advisor will evaluate all of the options to ensure the best decision. Keep reading.

Round 4: Cost

Section 529 administrative and advisory costs can range from 0.25 percent to 1.85 percent according to Morningstar, but charges on cash value insurance policies can easily top 2 percent, says Kuhner. To reduce the costs, Kuhner advises families to insure the student rather than listing him or her as the beneficiary.

“The mortality charges are going to be much less,” he says, adding that policies for young, healthy kids are substantially cheaper than those for adults.

Besides paying higher administrative and advisory costs, Peter Laurenzo, a Certified Financial Planner and president of College Aid Planning Associates Inc. in Albany, N.Y., says parents saving for college in an insurance policy won’t get a state income tax deduction that many 529 holders receive.

“In a New York 529 plan, (families) get a state tax deduction up to $5,000 per parent,” he says. “That’s significant.”

However, not every state offers a 529 deduction, and most that do only offer it to residents invested in that state’s plan.

Before enrolling in a life insurance or 529 plan, comparison shop and have a financial adviser crunch the numbers to see whether the no-risk returns of a life insurance plan outweigh the costs and lost tax deduction.

The charges inside of a cash value life insurance policy will differ from one policy to the next depending upon the age and health of the insured, the death benefit, how much money you are contributing to the policy, the product type, and the insurance company issuing the policy. AWAYS ask to see an expense report. I love to show clients expense reports for Indexed Universal Life Insurance policies especially when they are insuring a child. You will be shocked by the low policy expenses. To be clear, if your goal is to maximize growth in a short period of time always place the policy on the life of the child. This does not mean you give up control of the money. It simply means you are minimizing the expenses so that you can maximize the growth potential.

Pay very close attention to the rest of this post. When designed and accessed properly, the cash value of an Indexed Universal Life Insurance policy is INCOME TAX FREE. Who cares about a $5000 tax deduction for each parent? Do you know what a tax deduction is? If there are 2 parents on the tax return it means that $10,000 would be deducted from the taxable income of the household before the income tax is calculated. Currently, the highest income tax bracket in the state of New York is 10.9%. That “deduction” would save them a maximum of $1,090 one time. Compared to accumulating $150,000 in an Indexed Universal Life policy and using it to pay for college, a wedding, a house, a car, a vacation… ANYTHING you want… INCOME TAX FREE, both state and federal. You see, the 529 plan is tax-favored if you use the money for a qualified expense but if you save too much or your child decides not to go to college and there is no other beneficiary who can benefit from the 529 plan assets, the money must be distributed with federal and state income tax and possibly a 10% penalty due when you file your next income tax return. Saving $1,090 one time is not enough incentive for me to restrict when and how I can use my money.

Yes. There is another way to pay for college. If you are looking for a flexible college savings plan with no stock market risk that will ghost the financial aid formula and not break the bank, consider placing an Indexed Universal Life Insurance policy on your child as soon as 14 days old. Yes. Don’t wait. Locking in their insurability early minimizes the cost of the policy.