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College Financial Planning

Life Insurance and College Funding                  

Using Life Insurance as a College Funding Supplement 

College costs are considered a major expense for most individuals. As a parent, it is important to take a proactive approach when investing for your children’s college goals. While there are a variety of products and accounts in the marketplace, you may want a plan that will give you flexibility, as well as coverage for your family should something happen to you.

Understanding the Options

There are many ways to save for your children’s education.  What are some of the options you have?

1) 529 Plans:  These plans are very popular.  Individuals select these accounts because they offer a way to save for college and they have tax benefits associated with them. These plans grow tax-deferred and the money can come out tax-free if utilized for qualifying higher education expenses.  However, many individuals have concerns over flexibility as it pertains to these types of accounts. For instance, if a 529 plan is not used for college education, a 10% penalty and taxes are issued on the gain within the plan.  While there are some ways to transfer the beneficiary designations to a family member (you can transfer from on sibling to another in most plans), what if that option is not available/applicable for your family? You will also need to consider limits – most 529 plans have restrictions to haw much money can be invested, and while these limits are high, there is a ceiling. 

2) UTMA/UGMA Accounts:  For practical purposes, these accounts are for the exclusive benefit of a minor, but name a custodian to manage the account until that child reaches the age of majority (anywhere between 18-21 years, depending on the state).  These types of accounts do not necessarily have to be used for higher education, but they do transfer to the minor as soon as he or she reaches age of majority.  If that child does not go to college, they can use that money for whatever they wish.

3) Coverdell Education Savings Plan: These accounts have income limitations, and in 2013, you can only put away $2,000 per year.  These accounts grow tax-deferred and the money is tax-free if used for qualifying education expenses.  You can also use these accounts for education expenses prior to college, so a private high school may qualify, for example.

4) Mutual Funds and Retirement Accounts: Mutual funds can offer the most flexibility because money can be invested and withdrawn without any additional tax penalty.  Money in the account belongs to the owner, and as such, the owner can control who receives distributions, if there are any.  Mutual funds have taxes associated with them, such as capital gains and dividends.  Although retirement accounts, including 401(k)s and IRAs are typically reserved for retirement spending, some people will earmark a portion of money in these accounts to fund a college education.  While money in a retirement account grows tax-deferred, most individuals should be aware that access to this money prior to 59½ may result in a 10% penalty and tax will be associated with the withdrawals. (IRAs may be accessed for higher qualified expenses, without the 10% penalty.  Please consult your tax advisor for more information.)

5) Permanent Life Insurance: Life insurance provides a death benefit should something happen to you.  Part of the tax-free death benefit can be used to fund children’s education goals.  In addition, the cash value build up in a life insurance policy can be accessed for college education purposes.  The cash value is tax-deferred and come out tax-free if the contract is structured properly.  If your child does not need money for college expenses, the cash value can continue to guild for your future goals, such as retirement.

Financial Aid

It should be noted that financial aid packages that are generated for most students consist of loans, while grants and scholarships are often secondary.  Some institution may have additional requirement for determining aid, although most require federal forms.  In estimating a family’s ability to contribute funding for college, federal financial aid will consider the parents’ income and assets as well as assets and income in the child’s name.  Other factors, such as whether or not the child has other siblings currently enrolled in college, will also factor into the family’s ability to contribute.

Some assets are not considered when determining aid, such as 401(k)s and IRAs.  (Note: if you take out money from an IRA, this will count as income for the following year, as financial aid is determined on an annual basis).  Life insurance cash value is not currently factored on the federal level, but certain institutions may require it at their level.  (If a policy is surrendered, though, it would count towards the family contribution.)  Generally, UTMA/UGMA accounts re heavily weighted in determining aid and tend to have the highest impact whether or not aid is granted.

Benefits of Life Insurance

Life insurance can offer peace of mind in knowing that your children would be protected should something happen to you.  IN addition, money saved into life insurance has little to no limitations.  If your children decide to go to school, the money is there for you to access in a way that is tax-free.  If your children change their mind and delay going to school, you can use the cash value toward your own goals.  As an additional benefit, life insurance cash value can be used for a myriad of expenses associated with higher education – travel expenses, and spending money for instance – and it is not limited or restricted to qualified higher education costs.