Universal Life Insurance
Some families may find life insurance an attractive way to save for college.
The advantages of this type of investment are:
- non-assessment in the EFC calculation at most colleges,
- tax-deferred growth of earnings,
- availability of low-interest loans from the policy during college years,
- potential earnings of variable life policies to keep up with high college inflation rates,
- forced systematic savings by the family for future college costs,
- coverage of the future cost of college in the event of death,
- coverage of future cost of college in the event of disability, if the policy has a disability insurance feature, and
- possible protection from creditor claims.
Universal life insurance policies can serve a dual purpose for college fund investors:
- Provide the parents of dependent children with the security of insurance and a way to build up assets by disciplined savings.
- Provide fairly priced lifetime insurance coverage for the parents and accumulate value to tap for retirement income later in life.
The cash value of an insurance policy is its college investment component. The premium, paid by the parents, is applied to three areas:
- A mortality charge to fund the pure insurance, based on the insured person’s age, sex and health
- Commissions and administrative fees
- An investment account, which builds cash value for the policy owner
By tradition, insurance companies have been fairly conservative investors and developed policies in which cash value builds up at rates comparable to that of other conservative investment alternatives, such as CDs.
The special feature of most universal life policies is that they are flexible. You can generally suspend premium payments for a time or increase the premiums to build up cash value more quickly, borrow against cash value or make partial withdrawals. They can adapt to the differing insurance needs the parents may experience at various stages in life, including the period when you are building up a college fund. Like most life insurance, universal life enjoys special status under current tax laws. Death benefits are not taxed to the recipients. The cash value increased on a tax-deferred basis, which means that earned interest is not currently taxed. Under current tax laws, if a person borrows against the cash value, they do not pay tax on the sum withdrawn. However, if the policy is surrendered or partial withdrawals of the cash value are made, the policyholder is liable for current tax on the amount received, less the sum of the paid premium.
Variable Universal Life (VUL)
The VUL life insurance policy can provide clients with a better alternative for paying college costs. Not only does it provide control, wide investment selection, tax-free growth and tax-free withdrawals, but it also allows parents to pay for college without having to deplete their retirement savings. Better still, the policy provides the security of a policy death benefit to pay for college. In addition, making the premium payments on permanent life insurance is a forced savings. Most clients will not want to lapse the policy by not making the premium payments.
If parents continue to make deposits to VUL, when the time comes to pay the college bills, they can easily withdraw money from the contract, either as a cost-basis withdrawal or a loan on a tax-free basis. This makes VUL particularly ideal for college funding.
Cash-value life insurance can be an effective addition to your college fund if the insurance is needed. So the first step is to assess the need, or identify a possible insurance gap. This can be done using the following simple procedure:
- Estimate the annual expense of maintaining the family’s current standard of living.
- Estimate the household income following the death of a major provider.
- Estimate the income that could reasonably be generated by investing the lump sums payable to family survivors from pension and profit-sharing plans and existing life insurance policies.
- If there is a gap between estimated expenses and income, adding additional life insurance as part of the overall college funding plan should be considered.
Also, it must be decided whether to fill an insurance gap by buying term insurance or cash-value life insurance. If the gap between the household’s expenses and its income after the loss of a major provider is substantial, especially during the child’s college years, a five-year term policy to cover the extraordinary expenses during that period could be the most economical choice.
On the other hand, clients that start saving early and incorporate a cash-value life policy as one of the components of their college funding, could be protected by a substantial death benefit. They could also use the cash value to build up to help meet college expenses, then continue the policy to build financial resources for retirement or provide a financial legacy. Many policy owners need at least ten years to build up enough cash value to make the substantial borrowing for college expenses practical.
Cash-value life insurance is also an easy way for grandparents to help their children and grandchildren while remaining in control of the buildup of cash value, which they might need to meet personal financial emergencies during their own lifetimes.
A feature of VUL not available with non-insurance investments is specified-premium waiver. If the insured is disabled, the waiver will pay the cost of insurance on the client’s behalf. The policy will continue, and funds can be withdrawn for college.