Life insurance a lifesaver for college?

More advisers considering it but some want the practice banned

Feb 14, 2013 @ 4:01 pm

By Liz Skinner

Parents worried about how they'll afford the soaring cost of college for their children increasingly are being steered by financial advisers in a surprising direction — life insurance.

Life insurance that carries a cash balance that can be pulled out and used to pay for higher education offers tax advantages over the popular 529 college savings plans, according to some advisers. It's also a better way to pay for college because the assets aren't counted in the calculations used to determine financial aid eligibility, they contend.

Jeremy Turner, a financial adviser and president of Safe College Funding LLC, said he steers about 10% to 15% of his middle-income clients in the direction of life insurance to plan for college costs.

“It's not a one-size fits all approach,” Mr. Turner said. “It takes some crafting to make sure it's the right fit.”

Many college-funding experts, however, find flaws in the use of insurance for college funding, especially for higher-income families who won't qualify for financial aid regardless of whether those assets are accounted for in financial assistance calculations.

But financial aid expert Mark Kantrowitz said in a new Morningstar Inc. report that using life insurance to pay for college should be banned. The policies are expensive and include high commissions for the salesperson, who, he said, benefits more than the family purchasing the policies.

While the insurance policies aren't counted as parent assets in the calculation of financial aid, the cash value pulled out of the policy is treated as income and does count the following year in aid calculations, Mr. Kantrowitz said. Policyholders who take on a loan through the policy should not have those amounts considered toward financial aid.

Still, a new survey suggests that more advisers are beginning to consider the idea.

About 29% of financial advisers recommended that clients use life insurance products last year to save for college, a figure that was up from 23% in 2011 and 21% in 2009, according to a new survey by Financial Research Corp.

The life insurance policies being used this way could include whole-, universal-and variable-life policies that allow owners to withdraw a certain amount of the paid premiums without paying taxes or a penalty. Some of the policies, alternatively, allow holders to take out a loan from the insurance company using the cash value of the policy as collateral.

Gerber Life Insurance Co. has been selling a College Plan policy for about three years aimed at households with an income of $30,000 to $75,000 a year. The firm has sold tens of thousands of these endowment life insurance policies and saw a 40% increase in new customers in 2012, according to the plan's chief marketing officer, George Thacker, speaking today at the College Savings Foundation's annual meeting in Scottsdale, Ariz.

Funding college through a life insurance policy will make the most sense if the policy owners need long-term life insurance and plan to hold the policies for life, according to the Morningstar report. A “complex cost-benefit analysis” is needed to determine whether this strategy makes sense for a particular family, the report said.

Assets that parents save in Section 529 college savings plans are counted in need-based-aid calculations and can reduce aid by a maximum of 5.64%. Of course, most 529 plans incorporate state tax deductions, and account withdrawals from the plans aren't taxed as long as they are used for higher-education expenses such as tuition.

State Farm Life Insurance Co. sells insurance policies aimed at complementing a 529 college savings plan, said director David Theile at the college savings meeting. His firm focuses on selling policies that provide a death benefit to fund the balance of college costs should something happen to a parent, he said.

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