College Savings Plans
One of the biggest worries for parents is how they are going to save for their child’s college education. In 2016 the average debt for a graduating student was $37,000. And even more significant, if you are interested in sending your child to a private school, you need to consider this average annual tuition in 2016-2017 was $34,380. What is most alarming for those of us with younger children, according to the Forbes article “Student Loan Debt in 2017: A $1.3 Trillion Dollar Crisis,” over the next 20 years, we can expect a staggering 296% increase in tuition and fees at public universities. How is a parent expected to plan for these exorbitant increases?
529 College Savings Plan
The “go to” plans for most parents are 529 Plans, Coverdale ESAs (Education Savings Accounts), and state tuition savings programs. Setting aside funds in these plans is certainly better than doing nothing, but these plans have inherent shortfalls. A 529 Plan is really a brokerage account that can go up during a market rally but can also drastically drop in value when the market slumps. Imagine having this plan if you were sending your child off to school in 2009—just after the 2008 market crash. Other factors related to 529 Plans are you can only reposition your funds once a year, and if you need to pull your money out of the plan for non-education expenses, you will incur a tax liability and a 10% penalty. Prepaid state tuition plans can work well, but only if your child goes to school in your state. Coverdale ESAs are also investment accounts dependent on market fluctuations so could potentially lose value, and they have lower contribution limits than a 529 Plan—$2,000 per beneficiary in 2017. Most parents are completely unaware there is an alternative that doesn’t cap the amount you can contribute, has no downside of principal loss, and the funds can be used for any purpose without penalty. This alternative is properly structured cash value insurance.
How do you use cash value insurance for college funding? The first, and most important, step is working with a professional who knows how to structure a policy for capital growth. As I discuss in my book The Private Vault, the key is to design the policy so it has the lowest coverage possible for the premium that is paid into the policy. By minimizing the coverage, the majority of the premium payment is allocated to growth instead of insurance cost. It is essential the policy be designed to accumulate as much tax-free growth as possible. This strategy works for both dividend paying whole life insurance and Indexed Universal Life (IUL) Insurance. Both types of policies are designed to accumulate capital and have the same access to capital for any purpose. The distinction between these policies is based upon how they grow in value. Dividend Whole Life Insurance grows in value based upon dividends being paid to the policy holders as determined by the board of directors of the insurance company. In a Dividend Whole Life Policy, we generally see a 5% to 6% growth opportunity. An IUL has two growth buckets. The first is an interest-bearing account, and the second is the index account. It is in the indexed account where we see the real growth opportunity. The account grows by linking to an index (i.e. S&P 500), and the gains are forever locked in; if the index goes down in value, you don’t lose any underlying principal. Historically, we see a little shy of an 8% annual return when linked to the S&P 500. This return is just an average, so there will be years where it is higher and years where it is lower, but it never drops below 0%. An additional benefit of cash values inside an insurance policy is the capital is not treated as a qualifying asset when parents are looking to qualify their child for financial aid. Theoretically, a parent could have millions of dollars inside a policy, and it would be exempt for financial aid purposes.
Let’s take a look at a couple of examples. The first is my client who just created an IUL for his one-month-old son. He and his wife have decided to pay an annual premium of $3,000 for this child. Based upon an average growth rate of 7.05%, the policy is projected to have $98,000 that the parents can access for his college expenses. One strategy we often employ is to have the child apply for student loans while in school. The payments on the student loans are deferred until after graduation. Employing this strategy for his child, my client will see the policy is projected to have a cash value of a little over $156,000 by the time his son has completed his education, and it can then be accessed to pay off the student loans.
Saving For College
It doesn’t necessarily have to be a parent who sets up a policy to pay for education. I recently prepared a proposal for a grandmother looking to fund her 3-month-old granddaughter’s future college expenses. The grandmother wants to allocate $10,000 annually to a policy until her granddaughter turns 18. When the granddaughter turns 18, the policy is projected to have $309,873—based upon an average index growth rate of 7.11%. If she decides to wait to pay for the student loans when her granddaughter graduates at 22, the policy is projected to have $408,065. If her granddaughter decides not to go to school, the grandmother can access the funds at any time via a tax-free loan.
As parents, we have a variety of options to save for our children’s, and even grandchildren’s, education expenses. We don’t have to fall back to the old standbys of 529 Plans, Coverdale ESAs, or Prepaid State Tuition vehicles. Using properly designed cash value life insurance is a little known, yet incredible, method to help cover college expenses. By using these policies, the parent or grandparent is not restricted in accessing the capital. It comes out tax free, and there is not the risk of underlying loss based upon the adverse market performance you may experience if an IUL is used. Additionally, since this is insurance, if the unfortunate should happen and we pass away prior to our children going to college, the death benefit is there to help cover the costs of education.