At
the top of parents’ long-term goals for their children is making sure their
children receive a high-quality education.
But
as college costs climb and climb with no end in sight, it’s become harder each
year to afford a high-quality college education without taking on a
crater-sized debt.
The
most popular vehicle parents use to save for their children’s college education
is the 529 College Savings Fund. But lately, a newcomer has entered the fray:
Whole Life Insurance. Well, it’s hard to call whole life insurance a “newcomer”
because it’s been around since Civil War – before a college education was even
considered a possibility for middle-class families.
Nevertheless,
whole life insurance has also become a popular way to save for college – giving
parents two strong options. This blog will sort out the pros and cons of both
and show you which one is truly the best way to save for your children’s
college education.
529
College Savings Plans – The Pros and Cons
College
saving plans (commonly referred to as 529 plans) have gained much fanfare in
the past decade – especially as tuition costs rise while the average American’s
salary remains stagnant.
Indeed,
there’s a lot to like about them. First, as most know by now, accumulated
earnings are tax-deferred and withdrawals are exempt from federal income tax
and state taxes when used for “qualified higher education expenses.”
Other
benefits include:
- Friends and family members can also contribute to a 529 plan.
- The account holder can change the beneficiary if the original beneficiary decides not to go to college or does not use all the funds.
- 529 plan funds can be used at the vast majority of most colleges and universities in the United States.
But
there are drawbacks:
- Plans vary from state to state. And many states allow you to open a 529 Plan in their state without even being a resident in it. This element alone multiplies the time and effort a family has to spend researching the different plans offered by each state. Investment options, sales charges, account fees – all differ between plans. The overload of options and the time spent researching each can be a serious source of stress that causes a family to delay even starting a fund.
- If money from a 529 plan is withdrawn and not spent on what’s considered a “qualified higher education expense,” it would likely be subjected to income taxes and a penalty tax as high as 10%. We all know that college expenses don’t stop at room, board and books. Working in such a big gray area of uncertainty is often not worth the risk of paying unexpected taxes on a big ticket item (i.e. car) that is college related to you but not to the guidelines of the 529 plan.
- Finally, a 529 plan can reduce your beneficiary’s ability to receive income-based financial aid. If this happens, it can render the savings plan useless since it just increased the total amount of money you’ll pay for higher education.
Why 529 Plans Are Losing Their Cool
You’d
think that with the ever growing importance of a college education – combined
with wildly escalating tuition prices – the popularity and reliance on 529
College Savings Plans would increase as well.
“Assets in 529 college savings plans (which differ from
529 prepaid tuition plans) fell from a record high in the first quarter to
$157.5 billion in the second quarter – a 0.5 percent decrease, according to
Financial Research Corp. (FRC) in Boston. In the third quarter of 2011, net
inflows were negative – more funds flowed out than flowed in – the first time
that happened since the middle of the Great Recession. In the first half of
this year, net inflows were nearly 7 percent below the same period last year
and about 60 percent below The second quarter’s $2.9 billion in net inflows
(contributions minus withdrawals) were 12 percent lower than they were a year
earlier, and down nearly half from their pre-recession heyday in the mid-2000s.”
When
you think about it, the mid-2000s were the heyday for a lot of things whose
stars have fallen dramatically. Less than a decade later, we’re living in a
very different world. And more and more people are starting to realize that the
“Emperor (529 Plans) has no clothes.”
That,
and they are also realizing that whole life insurance, specially cash value
life insurance, as a college savings tool is a better option.
One
of those people, according to the article, is a former stock broker Brian
Solik. Given his profession, if anyone would know firsthand that we’re not
living in the mid-2000s anymore, it’s him. After the stock market crash in
2008, he stopped contributing to the three 529 plans for his children and
instead began using cash value life insurance for college savings.
His
reason – no surprise – was safety. Taking a hit to your investment portfolio is
one thing. You have to expect that to a certain degree. But when your
children’s college savings starts losing value, it’s time to rethink your
strategy.
Whole
Life Insurance – The True Solution for College Savings
Whole
life insurance is hands down the better college savings plan than actual
college savings plans.
Among
whole life insurance benefits:
- Whole Life allows you to save for any person, business or charity regardless of their relation to you. You can also choose multiple beneficiaries, divided up to receive whatever percentage you set for each. This is a far greater area of flexibility compared to college savings plans, which limit your beneficiaries to family members and close friends.
- Whole Life plans offer unlimited ways to spend your money. Money withdrawn from a college savings plan is only allowed to be spent on pre-qualified college expenses or else be subjected to federal income tax and possibly a 10% federal tax penalty. Last time I checked, college students ate food, buy clothes, put gasoline in their cars, etc. Whole life plans can help pay for this without penalizing the student.
- Whole Life plans have attractive interest rates, regular dividends and no downside risk. That’s right, zero risk. Whereas many college savings plans are subject to the turbulent stock market. Can you imagine putting money away for years only to find out that what you cash out is less than the amount you put in?
- Whole Life plans won’t jeopardize a student’s chances of getting additional financial aid. Compared that to money in a college savings fund, which is factored into the financial aid calculator.
- And most importantly, guaranteed completion. By that, I mean a Whole Life plan has the ability to guarantee that a savings target will self-complete under all circumstances.
It’s
amazing that this secret hasn’t spread like wildfire. Perhaps that can be
attributed to the name – whole life insurance. Few people know that it can do
so much more than insuring the loss of loved one – for everything that happens
in life from college and retirement. It’s time that the world knows more about
the full capacity of whole life insurance.
So let's recap the differences:
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.
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.
Financial Aid
One of the major advantages to 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.
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.
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.
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.
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.
Contact me TODAY!
John L. Nunes
President & CEO
J. Nunes Fianncial
john.nunes@jnunesfinancial.com
John L. Nunes
President & CEO
J. Nunes Fianncial
john.nunes@jnunesfinancial.com