The three biggest financial challenges in one’s lifetime are retirement, buying a home, and sending a child to college. With college costs rising nearly every year the thought of saving for your child’s education can seem overwhelming.
Fortunately there are a number of tax-saving plans available.
One is the Section 529 Plan, which is a state-sponsored investment program named after Section 529 of the IRS Code. The main benefit of a Section 529 plan is the money can grow tax-free and be withdrawn tax-free for college education expenses. However, suppose your child would rather work than go to college, or better yet, suppose he or she gets a full scholarship? In that case the money could be taxed like an IRA, with similar income taxes and penalties.
An alternative to the Section 529 plan is life insurance as the savings vehicle. The benefits of life insurance over a Section 529 Plan include the following:
1) Tax-Free Accumulation and Withdrawals. Life Insurance is one of the most tax-favored vehicles for accumulation of wealth in the United States. Life Insurance Cash Values are exempt from taxation under current law unless the insurance policy is surrendered or becomes a Modified Endowment Contract. The accumulated cash values may be withdrawn or borrowed, tax- free, at will by the policy owner. Death benefit proceeds are also income tax free.
2) Flexibility of Contributions. The maximum investment amount varies from state to state, most states do not permit more than $250,000 to be invested in any one Section 529 plan. Once the plan value has reached the maximum amount permitted by state, no more contributions can be made. By contrast, the amount that can be invested in a life insurance contract is limited by the death benefit the insured can qualify for and the Internal Revenue Code limits for the contract to remain qualified as life insurance. In most instances, an investor can invest more in a life insurance contract than in a Section 529 plan.
3) Full Funding on Death of the Insured. The insurance contract, if designed properly can automatically, fully fund education expenses with tax free dollars if the insured dies before being able to invest enough to fund the college plan. Even if the insured dies one day after the policy goes into effect, the full death benefit is paid tax-free and can be held in a separate account until the child needs it for college. Most policies also accelerate a portion of the death benefit if the insured is diagnosed as being terminally ill. It is critical to include a waiver of premium rider for the full contract premium, if the parent becomes disabled, the policy will be funded by the insurance company. By contrast, if the owner/contributor of a Section 529 plan dies or becomes disabled two years after the plan is established, the funding stops, the plan fails, and the child may lose his or her chance at a college education.
4) Planning Advantages. Unlike securities market returns, which can be positive or negative, dividends paid on life insurance policies always generate a positive return. Obviously, this does not guarantee the goal will be achieved. However, even when the dividends do not keep pace with projections, it may be possible to make corrections on an annual basis to cover any shortfalls that may occur. This is much more difficult with Section 529 plans, not only because of the restrictions on contributions, but because the volatility in returns could make it impractical.
5) Financial Aid Eligibility. Section 529 plans are college savings plans and thus are included in the parent’s assets when calculating the Expected Family Contribution for financial aid eligibility. For purposes of determining financial aid, the life insurance policy is owned by the parents and thus is not included in the student’s assets. The cash value of the policy is also not included in the parents assets used in the Estimated Family Contribution calculation; therefore, the life insurance funding plan does not affect financial aid eligibility.
6) Liquidity. With a life insurance funding plan you do not have to wait until your child graduates before accessing the savings, you may access it at any time. The funds may be accessed in case of emergencies, and there are no restrictions on how the funds are used. However, with Section 529 plans the funds may be used solely for college tuition and related expenses.
Additionally, this plan could also be utilized as a foundation for a tax-free retirement savings vehicle to provide a head start on improving one’s position for that major concern.
For more information about using life insurance for a college and retirements savings plan, please call or email us today. It is never too early or too late to start saving.