College education: an investment for a lifetime

No one needs life insurance, though it is highly recommended for people who fit certain criteria. Those with significant debt, who are married, have children, or have an independent business venture are strongly recommended to get life insurance.

As any parent knows, the safety and well-being of their children are always their top priority. However, parents also have a responsibility to plan for the future and prepare for the possibility of their child's death. While it's never an easy topic to think about, it's essential to be aware that in the event your child passes away, any student debt they have can be passed on to their parents. The debt could become the responsibility of the parents, and they will be required to make payments on behalf of their child. If the parents cannot repay the debt, it could negatively impact their credit rating and financial stability. As a result, it's essential to have a conversation with your child about their student debt and to make sure that you have a plan in place in case of their death. Taking these steps can help protect yourself and your family from financial hardship in the event of your child's death.

KEY TAKEAWAYS

• 529 plans are tax-advantaged accounts that can be used to pay educational expenses from kindergarten through graduate school.
• There are two basic types of 529 plans: educational savings plans and prepaid tuition plans.
• 529 plans are sponsored and run by the 50 states and the District of Columbia.
• The rules and fees of 529 plans can differ by state.
• 529 plans can be purchased directly from a state or via a broker or financial advisor.

Although 529 plans take their name from Section 529 of the federal tax code, the plans themselves are administered by the 50 states and the District of Columbia. Anyone can open a 529 account, but they are typically established by parents or grandparents on behalf of a child or grandchild, who is the account's beneficiary. In some states, the person who funds the account may be eligible for a state tax deduction for their contributions.

The money in a 529 plan grows on a tax-deferred basis until it is withdrawn. What's more, as long as the money is used for qualified education expenses as defined by the IRS, those withdrawals aren't subject to either state or federal taxes. In addition, some states may offer tax deductions on contributions. In the case of K-12 students, tax-free withdrawals are limited to $10,000 per year. Since tax benefits vary depending on the state, it's important that you check the details of any 529 plan to understand the specific tax benefits that you may or may not be entitled to.

529 savings plans are the more common type. The account holder contributes money to the plan. That money is invested in a pre-set selection of investment options. Account-holders can choose the investment (usually mutual funds) that they want to invest in. How those investments perform will determine how much the account value grows over time. Many 529 plans offer target-date funds, which adjust their assets as the years go by, becoming more conservative as the beneficiary gets closer to college age.

Withdrawals from a 529 savings plan can be used for both college and K-12 qualified expenses. Qualified expenses include tuition, fees, room and board, and related costs. The SECURE Act of 2019 expanded tax-free 529 plan withdrawals to include registered apprenticeship program expenses and up to $10,000 in student loan debt repayment for both account beneficiaries and their siblings.

Prepaid tuition plans are offered by a limited number of states and some higher education institutions. They vary in specifics, but the general principle is that they allow you to lock in tuition at current rates for a student who may not be attending college for years to come. Prepaid plans are not available for K-12 education.

529 plans have specific transferability rules. The owner (typically you) may transfer to another 529 plan just once per year unless a beneficiary change is involved. You are not required to change plans to change beneficiaries. You may transfer the plan to another family member, who is defined as:

• Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them
• Brother, sister, stepbrother, or stepsister
• Father or mother or ancestor of either
• Stepfather or stepmother
• Son or daughter of a brother or sister
• Brother or sister of father or mother
• Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law
• The spouse of any individual listed above
• First cousin

How Much Does a 529 Plan Cost?

States often charge a one-time account setup fee for a 529 plan. These have ranged from as little as $25 (in Florida) to $964 (in West Virginia) for the lowest-cost option. In addition, if you bought your 529 plan through a broker or advisor, they may charge you as much as 5% or more on the assets under management. The individual investments and funds that you have inside of your 529 may also charge ongoing fees. Look for low-cost mutual funds and ETFs to keep management fees low.

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There are many benefits of using permanent life insurance as an investment. Pros of using life insurance to save for college include:

• Financial aid – When your child applies for financial aid for college, the savings in your life insurance account are not considered.
• Tax advantages – Funds in your permanent life insurance account grow tax-deferred, like those in a 529 plan.
• Savings can be used for anything – Unlike a 529 plan, the savings in your life insurance account can be used for anything (beyond college costs). If your child decides not to go to college, you can still use the accumulated cash during your lifetime without being penalized. For example, many people use permanent life insurance to supplement their retirement savings.
• Flexibility – There are several ways you can use your savings to pay for your child’s college tuition:
• Borrow against the cash value (which is easier than taking out a traditional loan, plus the interest rates are usually lower)
• Withdraw a portion of the cash value

Cons of Using Life Insurance for College

While using permanent life insurance as a way to save for college has several advantages, there are also several drawbacks.

• Takes time to accumulate cash value – While it’s always best to start a college savings fund as early as possible, with permanent life insurance, it’s essential. It usually takes 10 years for the amount in your cash value savings to surpass the amount paid in premiums, which means you’ll need to buy this type of life insurance before your child is born or immediately after in order for it to be worthwhile as a savings vehicle.

Accessing the Cash Value of a Permanent Policy

There are several ways to access the cash value of your policy to pay for your child’s college education. You can:

• Take a loan against the value of your policy, which you must pay back in full. (If you die before the loan is paid back, the outstanding debt will be taken off the policy’s death benefit.)
• Withdraw the cash value, so you don’t need to pay back the loan but you know from the get-go that the death benefit will be reduced.
• Surrender the policy and receive the entire cash value. A universal life policy will also have a surrender fee charged by insurers. This is the least ideal option, since your entire policy will be liquidated.

Bottom Line

Yes, it’s possible to use life insurance to pay for your child’s college education. In addition to the death benefit that’s standard to all life insurance policies, the cash value of a permanent policy can be used as a sort of child life insurance college fund. When deciding which investment vehicle to choose, the main thing to keep in mind is that in order for a permanent policy to be a worthwhile savings plan for college, you need to buy it when your child is a baby or toddler.

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Term life insurance is usually the best life insurance for college students, since permanent policies are significantly more expensive. A term policy is an ideal choice for a college student who has student loans. A life insurance policy can ensure that their debt doesn’t get passed to their parents or loved ones if something happens to them. In this case, the length of the term needs to be based on the number of years it will take to pay back the student loans.

If at some point during the term, the student gets married and/or has kids, they may want to convert their policy to a permanent one or buy an additional term policy to cover their new expense.

For parents buying life insurance as a way to save for their children’s college tuition, whole life insurance is a popular choice for college savings, although some prefer universal. Either way, it’s important for parents to choose a type of permanent life insurance that includes a cash value in order for the policy to be used for college savings.

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