Funding College: 529 or Life Insurance – Do You Really Need to Choose?

Funding College: 529 or Life Insurance – Do You Really Need to Choose?

A discussion has been running around our virtual office of late – what’s the best way to fund a child’s university education?

The 529 college savings plan has earned widespread popularity, but the usefulness of permanent life policies cannot be overlooked. Which is the best way to go?

Recent industry surveys were the motive force behind our talks. Surveys reveal that 529 plans have suffered from the decline in underlying markets, another victim of the coronavirus pandemic. These plans are structured like many investments: risky in the earlier years, conservative and relatively safe later on, as the child approaches college age. Research by Morningstar suggests that accounts covering children age 4 and under have lost 19% on average, while those for 17 and 18-year-olds have dropped around 5%.

In the former case, there should be ample time for markets and accounts to recover. For the latter, recovery should also be on the cards, but the timeframe is beyond prediction. Surprise events and market shocks should always be on investors’ minds. Planning, whether for retirement or a child’s education, must factor in risk. For parents about to launch their offspring into the higher education system, any shortfall will have to be promptly met by other resources. In such cases, we believe permanent life insurance is a particularly useful tool to have in one’s belt.

We’ll spare you some of the suspense: I think both should be recommended to clients, in equal measure. The benefits of 529 plans are many, mirroring to a great extent those of the widespread 401(k) plans, which we’ll discuss presently. Permanent life insurance, in particular the varieties that offer a cash value component, are exceptionally useful as a tuition-planning vehicle and carry an invaluable feature that is often overlooked when contemplating the kids’ collegiate futures: the death benefit.

That’s how we answer the earlier question: the best educational-funding strategy combines the 529 with a permanent life policy. When should you launch a 529 plan? Immediately after celebrations surrounding the birth of a new child cease (young mothers, put that cigar down; it’s actuarially unsound). These accounts need plenty of time to grow. The funding limits are fairly high: $15,000 can be contributed annually per individual contributor, and if two parents are involved, the limit is $30,000. However, most parents can’t reach that height, making time and steady investment the key to success.

The 529 by itself is an excellent investment vehicle for its purpose, but we don’t think it’s robust enough to go it alone. At this point, an investment advisor would likely raise the question: what if the unexpected occurs? Not bad, but brace yourself now for the insurance specialists, speaking from long experience: what will happen if you die?

The life insurance talk is a perennial unsettler, but a strong motivator. Parents want to protect their dependents. Setting children up for a higher education, and the opportunity for a comfortable, fulfilling life, is a matter of pride. We find that heirs, in such cases, tend to be forever grateful for their parent’s foresight and love – money often disappoints, but education can never be spent or frittered away.

The cash component of a permanent life policy is a useful tool for funding a college education. Meanwhile, the death benefit should not be ignored.

If one half of a couple suddenly dies, the surviving spouse is left with many burdens to shoulder, emotional and financial, but if properly provided for, they can carry on. But consider this: there are around 14 million single parents in the US today, caring for more than 20 million children. Life insurance, in these cases, hardly seems an option.

Young people starting families need life insurance. Term policies are the most popular way to start, as they’re the cheapest. Once financial stability is achieved, it’s time to consider permanent life. These policies don’t come cheap, but for clients with lofty financial goals – like securing a higher education for their children – they are hard to beat for flexibility, to say nothing more of the stabilizing power of the death benefit.

Buying a 529 plan is easy: there’s no income requirement or health screening, as in the case of permanent life. The annual fees are lower for the 529, particularly if purchased directly from a provider, rather than through an agent. Contributions to 529s are determined by the depositor, while insurance customers must pay a regular premium, which can be high, depending on the coverage. In both cases, growth is tax free. No federal tax deductions accrue on either, but 30 states do offer deductions for 529 contributions.
Returns on 529s are not capped, but there’s no guaranteed rate, either – everything depends on the underlying investments. Permanent life policies come in myriad varieties, but most either offer a fixed growth or are linked to a benchmark. Some policies allow holders to meddle in the investment strategy, which can work if conducted in concert with a well-qualified financial advisor.

Permanent life policies shine in the flexibility they offer in accessing funds. By law, 529 college funding accounts are aimed at solely that goal, although recent legal adjustments allow parents to fund K-12, too. Holders can switch beneficiaries twice a year and freely take the account from state to state. Withdrawals are tax free if used to pay for college-related expenses, including tuition, books, laptops, housing and more.

However, using 529 money for non-educational expenses comes at a dizzying price, including a 10% penalty and federal income tax liability. This should obviously be avoided, but in a family emergency, if may be unavoidable. Problems can arise if a child chooses not to attend college, although the account can be transferred to another child or relative.

Permanent life policies allow withdrawals or borrowing on the cash value once the defined initial contribution period has passed. It takes some time for the cash portion to grow. On average, ten years must pass before it exceeds the value of contributed premiums. Once that hurdle is cleared, the funds can be accessed for any purpose at all, collegiate or otherwise. Fickle children can do nothing, in this case, to muddle your investment strategy.

Financial aid regulations should also be considered: a 529 is considered a parental asset, which taken together can reduce aid eligibility by as much as 5.29%. Life insurance is assessed differently by schools and has no impact on financial aid entitlement.

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