Parents of young children have a lot to plan for. College is a big expense and requires a strategy for saving. Finding the dollars to put away for college is the hard part. Where to save those dollars needn’t be difficult or confusing. A 529 College Savings Plan purchased directly from a state is often a low cost and flexible way to save, most programs handle the investment decisions, and make saving and withdrawing easy, too.
Here’s the 411 on Whole Life Insurance, it’s pitfalls and an alternative to save for the high cost of college
What is Whole Life Insurance?
Unlike term life insurance which provides coverage for a set period, for example, 20 years, and then coverage ends, whole life insurance is issued for your whole life. Whole life policies also build up a cash value inside the policy, based on the total premiums you pay and the interest the account earns. These policies have been around for a very long time, and insurance companies have been finding many uses for them, besides simply providing a death benefit.
Whole Life Insurance for college: how it’s supposed to work
Whole Life Insurance is sometimes touted as a wonderful way to save for college. Ever seen those commercials from a popular baby food brand selling their college saving program?
The concept is that a parent buys a whole life insurance policy (these premiums can be really expensive) and in 18 years or more, there’s sufficient cash value in the policy to cover the cost of college.
With the average in-state cost of attendance running close to $100,000 for four years, that means the life insurance policy will have pretty hefty annual required premiums. Whole life insurance policies don’t pay tremendous interest rates, after all, so don’t count on big returns on your investment. Life insurance agents like to focus on the guaranteed nature of their products – guaranteed cash values that won’t lose money. They don’t mention the polices can’t get stock market returns, or the guarantee that the parents will have to pay a “surrender charge” if they want to close out the expensive policy within the first five to ten years…or that the agent is guaranteed to make a hefty commission selling the product.
When college time arrives, the idea is the parent takes loans or withdrawals from their life insurance policy to pay for college. In the 20th century, before tax-advantaged 529 College Savings accounts were available, this concept had some merit because withdrawals or loans from a life insurance policy aren’t taxed. But today, that benefit pales in comparison to how a 529 College Savings Plan works.
529 College Savings Plans Are A Better Alternative Than Using Whole Life Insurance for College Funding
529 College Savings Plans allow parents to invest their savings in generally low cost mutual funds and generally get decent market returns on their college savings. These returns really help grow the account over 18 years or more, and the growth is not taxed. Also, many states, including Virginia, provide state tax benefits for your contributions. When the parents need to withdraw funds for eligible education expenses, there’s no tax on the withdrawals. The parents can stop or change how much they save any time, too, making these very flexible ways to save.
There are risks in investing through a 529 College Savings Plan. Investing in mutual funds involves the risk of loss. Withdrawals that are not for eligible education expenses are taxable. But we believe these risks are far outpaced by the low costs, state tax benefits, flexibility, and simplicity of 529 College Savings Plans.
If you want to save for college, check out your state’s 529 College Savings Plan offerings (here’s Virginia’s offerings.) If you want to protect your family with life insurance, research the wide range of life insurance products. But don’t use life insurance to pay for college, unless it’s to help your life insurance agent pay for their children’s college expenses.
Want to speak with a fee-only advisor about college planning? Contact us.