Using life insurance to fund college costs has become less popular since the introduction of Section 529 plans, but some financial advisers and carriers insist the strategy still works for some middle-income clients.
"There are clear advantages to using life insurance to pay for college, and there are advantages to using 529s," said Scott Berlin, senior vice president of individual life at New York Life Insurance Co. "If you're starting off with a younger child, [insurance] is a great tool to save for college."
To implement the insurance strategy, parents purchase a whole-or universal-life policy on a child at least 10 years before he or she begins college, providing time for the cash value to build up tax-deferred. When it's time to start school, the child can borrow against the cash value to cover costs.
SEEN AS OBSOLETE
The strategy is nothing new to advisers, who say that it made sense in the decade or so before the creation of 529 plans and educational savings accounts. But those options have made life insurance obsolete as a way to save for school, some advisers said.
"Nowadays, there are so many other options that work better for college funding that using a life insurance policy to fund savings doesn't make sense anymore," said Rick Brooks, a fee-only adviser at Blankinship & Foster LLC in Solana Beach, Calif.
Aside from the cost of the policy, advisers worry that using insurance for this purpose calls into the question the real intent for buying a policy on the life of a child — the ostensible purpose of life insurance, of course, is to replace a deceased person's income.
"The real question is: Why buy a death benefit on your child as part of the framework of a [savings] plan?" asked Philip G. Lubinski, a financial adviser at First Financial Strategies LLC in Denver.
Nevertheless, there are situations where the insurance policy could work in the parents' favor. For instance, it gives them greater control over the money. Funds in a 529 plan must go toward education, but there's always the possibility that college isn't in the child's future or that there aren't other beneficiaries to receive the account in that child's stead, Mr. Lubinski said.
"[With insurance], you're keeping total control of the money, with cheap internal costs and no limits to funding," he added. In comparison, many 529 plans have ceilings on contributions and the prepaid 529s have set payments.
Insurance is still used among middle-income investors who want to start saving for college at an early stage in the child's life and may not be able to afford a 529 plan, Mr. Berlin added. He has purchased policies on his children, with the expectation of using the cash value to pay for college.
However, parents who already are financially stretched are going to have a difficult time keeping the policy active if they borrow against the cash value, making it likely that the policy will lapse and become a taxable account, Mr. Brooks said.
Additionally, the cost of college is rising at an annual pace of 7% to 7.5%, much higher than the 3% to 4% rate at which the policies' cash value grows, he added.
"Why would you save for college over the child's youth at a 3% or 4% interest rate on a universal or whole-life policy?" Mr. Brooks asked. "Borrowing that much money from an insurance policy virtually guarantees having to make higher premium payments later to save the policy."
HYBRID SOLUTIONS
While middle-income families may struggle with the cost of funding a whole-life policy on a child for this purpose, advisers pointed out alternatives that could incorporate insurance solutions with college savings programs.
"Term on the parent would offset the risk of the parent's early demise at a lower cost than the whole," said Jason Whitby, a senior financial adviser at Investor Solutions Inc. in Miami. This, combined with an educational-savings account, could work for parents with an adjusted gross income of less than $110,000. However, the total contributions may not be more than $2,000 a year.
Other alternatives include the 529 prepaid plan, which permits parents to lock in tuition prices and can serve as another option for those who can't afford a 529 savings plan, Mr. Whitby added.
Although advisers are looking away from life insurance on children to solve most college funding problems, it works in some situations. Mr. Lubinski has a wealthy self-employed client who purchased a large policy on his child out of fear that the child's early demise would be traumatic enough to affect the business for months. Mr. Lubinski, a diabetic, also placed a policy on his children to guarantee insurability in case he passes on his ailment.
"Life insurance is a lot like prescription drugs," he said. "All the policies aren't bad, but you have to make the right prescription according to the individual's condition."
E-mail Darla Mercado at [email protected].
