It might not seem like where you store your child’s college money would have anything to do with where they attend college – good grades and innate abilities do that – but it does, now more so than ever. Section 529 plans have been the hot investing option for a while because they offer federal tax breaks and don’t count against students applying for financial aid packages. Unfortunately they aren’t the perfect investment that they seem to be. That’s why I suggest a permanent cash-value life insurance policy instead. Here’s a comparison of the advantages and disadvantages of both.
The IRS is very specific about what a 529 plan can be used to pay for during college. It can be used for qualified educational expenses only. This means tuition, fees, books, and room and board at specified accredited U.S. Universities. If your child chooses to forgo college, go to a foreign based school or enrolls in an unaccredited school you have two options – transfer the money to another beneficiary that will be attending college (if you have one) or take out the money and suffer a huge tax hit.
Life insurance doesn’t have any of those restrictions. The money is yours to do with as you please. It can be used for anything from buying a car or putting a down payment on a house to rolling over into a retirement account.
Whole and universal life insurance policies have guaranteed returns on the investment, especially if you have time on your side. 529 plans are dependent on the stock market and its fluctuations. That means that you may end up with a lower return on your investment by going with a 529 than you would with the guaranteed returns of a life insurance policy.
Financial Aid Considerations
This is a huge concern with many of my clients. 529 plans can affect the amount of financial aid that your student is able to get while a life insurance policy does not. According to calculations done based on the Department of Education federal financial aid formula a 529 plan can reduce financial aid by almost 6 cents on the dollar.
In the case of a life insurance policy, you can take a loan against the value of the policy and use it to pay for college expenses. This reduces the death benefit but doesn’t count against financial aid. It is important to note that you must take out a loan against the policy for it to be effective, cashing out the policy will count as income for calculation purposes that could result in almost a 50 percent hit on financial aid.
The deck is stacked in favor of the life insurance policy, but still the 529 plan is the darling of the media. To find out more about why 529(e) plans may not be the best financial vehicle for your student contact me today.