College planning for your child can begin in their infancy. The plan that you will be putting into place now needs to be able to perform many years down the road. Traditional college planning utilizes a 529 plan. Although 529 plans have favorable tax treatment for qualified education expenses, as well as a state tax deduction in some states, they’re not for everyone.
An alternative option is whole life insurance. Unlike a 529 plan, premium payments for a whole life insurance policy are not state tax deductible. However, whole life insurance has some
of the same contribution, accumulation, and distribution tax features of a 529 plan, and offers some additional benefits.
In order to take advantage of the tax benefits for distributions from a 529 plan, the distributions must be for qualified education expenses for the named beneficiary. Non-qualified withdrawals will be subject to taxes on the earnings in the plan, plus an additional 10 percent penalty. Your whole life policy would allow you to borrow money on a tax-free basis via policy loans, and doesn’t limit or restrict your use of the money. The loans received from the whole policy may be taxable if you let the policy lapse, or if the policy is a modified endowment contract (MEC).
The funds in a 529 plan can be tied to market return, providing a potential increase in account value year after year. But what if your child started college in 2009 when the market crashed? Depending on investments you selected in your 529 plan, you may not feel comfortable in your ability to pay for their college. Whole life insurance has guaranteed cash value that is not subject to market volatility, while it also provides an income tax-free death benefit to your beneficiary which can be used to pay for your child’s college education in the event of your death. The cash value in whole life insurance grows over time as you pay premiums. In the early years of your policy, the cash value may be less than your premiums paid. Therefore, whole life insurance may not be an effective college savings vehicle if you start the policy later in your child’s life.
If you were to become disabled, would you be able to cover your living expenses and still contribute to a 529 plan? 529 plans offer no options to fund the plan if you become disabled. Whole life insurance has an optional waiver of premium rider that, if chosen, can continue to pay the premiums while you’re disabled, ensuring the plan you put in place stays on track.
When applying for financial aid, your 529 plan would be identified by FAFSA as an asset to you, if you are the account owner, and would be recognized in your family contribution level toward college costs. Some colleges have the ability to view life insurance as an asset in determining financial aid. However, when applying for financial aid directly through FAFSA, the cash value inside your whole life insurance policy would not count as an asset to you under current FAFSA guidelines.
Whole life insurance can play a key role in paying for your child’s college, whether it is stand-alone or alongside a 529 plan. Although it does provide additional benefits, there may be situations where whole life insurance would not be appropriate. If not put in place when the child is young, the life insurance policy may not build enough cash value to properly cover college expenses. Yet, the additional benefits that whole life insurance does provide, together with the tax-preferred access to cash values, can make it a valuable tool for college funding.