Let’s say you are building your college savings bucket. You have committed a specific amount to set aside each month to build the bucket. Maybe you also have a lump-sum amount that you would like to add to the bucket. Now, you ask yourself – where do I put the money? Which vehicle do I use?
So you ask yourself four questions. How important is it to you for this money to be…
FAFSA and Profile Free (the cash does not go on the financial aid forms)
Guaranteed against losses (you will never lose your principal)
Liquid for college and other purposes (no penalties/taxes to access cash)
Tax efficient (growth and withdrawals can be untaxed)
Then you look at categories of vehicles and put a Y or N for each of the above questions.
Qualified Retirement Accounts – YNNN
Cash Value Life Insurance (Whole Life) – YYYY
Roth IRAs – YNYY
Annuities – NYNN
Bank (Savings, CDs, Money Market) – NYYN
Brokerage (Stocks, Bonds, Mutual Funds) – NNNN
College Savings Accounts (529s, UGMAs, UTMAs) – NNYY
You notice that one vehicle has all Y answers: Cash Value Life Insurance. But wait, haven’t you heard over and over that Cash Value Life Insurance is a “bad” investment? After all, that’s what Suze Orman and Dave Ramsey preach, isn’t it?
Recently, Troy Onink wrote a piece on the Forbes Blog about “so-called college advisors lurking at college aid nights at high schools across the country who are really just insurance agents aiming to sell unsuspecting parents life insurance and annuity products on the claim that it will get them more aid for college.” http://www.forbes.com/sites/troyonink/2014/11/04/consumers-beware-the-truth-about-life-insurance-annuities-and-college-financial-aid/
Under Mr. Onink’s uninformed assessment, I suppose I would be classified as one of these “so-called college advisors lurking at college aid nights.” Actually, I don’t lurk. I hold free monthly workshops (www.upay4college.com). My students have been admitted at their top choice schools, including USC, Vanderbilt, NYU, Columbia and more, many of them with financial aid awards of over $100,000 (over 4 years).
I am also a licensed life and health agent and I don’t hesitate to suggest a whole life insurance solution when appropriate. Perhaps, according to Mr. Onink, I am just one of the “good college advisors” out there. I also have an entire network of “good college advisors,” so his blanket condemnation of our industry seems incendiary and unjustified. So I would like to give you the truth about the truth about life insurance, annuities and college financial aid.
What is Cash Value Life Insurance?
Cash Value Life Insurance is a permanent type of life insurance that has a cash value component. You can think of it like a safe savings account with an attractive death benefit. There are three main types of permanent insurance – Whole Life, Variable Universal Life, Indexed Universal Life. Generally, life insurance cash values are not assessed in the federal financial aid formula. However, the three types have significantly different characteristics, so to lump them all together is like saying that all stocks are the same.
Whole life policies also can be designed with term and paid-up additions riders so they build accessible cash value fast – which can then be used to pay for college and anything else. (Fun random fact: Both Walt Disney and JC Penney started their companies with cash from their life insurance policies – because I’m sure banks were just signing up to give Walt Disney a loan when he pitched the idea of Disneyland. But I digress.) Where cash value life insurance is an appropriate recommendation, I strongly endorse a properly designed dividend-paying whole life policy, using a combination of base policy, term and level paid up additions riders for its unmatched guarantees and liquidity (among other potential college planning benefits).
Why should Whole Life be used in the college bucket?
As previously highlighted, cash value permanent life insurance is the only vehicle not assessed in the federal financial aid formulas, guaranteed against losses, liquid for any purpose and untaxed. The tax efficiency alone can save families tens of thousands of dollars in college costs because college is paid with after tax money. For example, if your effective tax rate is 30%, you need to earn $100,000 to pay $70,000 in college costs. The plan can also self-complete, meaning that if you pass away before or during college, the death benefit should be more than enough to cover all remaining college costs, also on an untaxed basis.
Another benefit is that (unlike a 529 plan), the family can access the cash while building the college bucket. If the family owns a business and wants to expand, they can loan the business money, pay back the loan, and deduct the interest on their taxes, all while building their college bucket. Why would they want to do that? See Walt Disney above.
Furthermore, the life insurance companies I recommend have a “non-direct recognition” classification. This means your participating whole life policy will not deduct any outstanding loan amount when accounting for any annual dividend your policy would earn. In layman’s terms, this essentially means your policy’s cash value will continue to build, whether the cash is in the policy or out on loan to the owner!
How do annuities play into this?
Like life insurance cash values, annuity values are not assessed on the FAFSA form – however they are assessed on the Profile form. Some people cannot qualify for life insurance, or they have a lump sum and are not able to contribute on an annual basis. In those instances an annuity might be a plausible solution for them, all things considered.
What’s the downside?
A properly designed whole life policy gains cash value quickly, however there are somewhat higher costs in the first years of a policy as compared to the costs associated with other vehicles. For example, I recently designed a policy for a client and the first year costs for the life insurance were $6867 versus $467 for a brokerage account fee (1.5%). Over the 30 years the client plans on having the policy, the life insurance fees were $8,317 and the brokerage fees were $140,497 – assuming the same cash values in each account. What would you rather do? Pay $8,317 for a guaranteed untaxed cash value with a death benefit or $140,497 for an unguaranteed taxed value with no death benefit? Especially if you need the cash to pay for college in the next few years?
Whole life insurance is also generally a slower-growth vehicle, but you will most likely see an average of 4-6% growth over the life of the policy. This growth is untaxed, so depending upon your tax bracket, the actual growth may be even higher. So no, you will not see the growth sometimes seen in the stock market. But you also won’t suffer the losses. As many people have experienced, if the stock market drops 50%, it needs 100% growth just to get back to where it was before. What happens if that drop comes just as your child is entering college? Think this couldn’t happen to you?
What about suitability?
Life insurance has very strict guidelines regarding contribution amounts. The death benefit is based on a client’s income and age, the annual premium contributions cannot be more than 25% of income, and any additional money must come from existing assets. Annuities also have guidelines regarding liquidity. A properly designed policy will take all of these factors into consideration – in fact, it must; otherwise the company will not issue the policy.
In Conclusion: No doubt, whole life insurance is not “sexy.” You won’t be able to brag about your insane on-paper ROI at cocktail parties. But the benefits for using this vehicle in your college bucket can clearly exceed any other vehicle out there. So the question really is, why wouldn’t you consider using a properly designed whole life policy in your college bucket? I might beware of any advisor who tells me differently.