Today, most people are saving money for college, using 529 plans. 529 plans have some nice tax benefits, some advantages and disadvantages. These plans are one of the most popular ways people save money for college. Today we want to introduce to you an alternate way to save for college. Though 529 plans* have potential growth at the end of the day, the investments in a 529 plan are not guaranteed and could potentially be worth less than what you actually saved. In addition, the traditional 529 plan balances can potentially have a negative impact on the overall financial position of the person saving money for college.
What I want to try to do today is to introduce you to this alternative way to save money for your children or grandchildren.
Parents or grandparents can fund a 10-pay life insurance policy on, let’s say, for example a 5-year old child, paying $1,000 a month ($12,000 a year) for ten years. Regular savings, including the 529 plans, could affect the child’s ability to take advantage of various forms of financial aid. Or let’s say your child gets a full scholarship, then the 529 money which now may not be used for college, could create a tax. However, in contrast having money in life insurance should not have any negative impact on the potential to receive financial aid. Especially when the policy is not owned by the child going to college.
The 10-pay life insurance policy alternative is unconventional thinking. When preparing to pay for college, students can apply for grants, scholarships, and financial aid, with the remaining balance to be paid by loans. These loans could come from home equity lines of credit, Stafford Loans (subsidized or unsubsidized), etc. When you take out a college loan, the debt is deferred while you are a full-time student. When due, the debt could be paid back, for example, over a 15-year period by loans from the 10-pay life insurance policy.
The insurance company currently has a 5% adjustable loan interest rate and a dividend interest rate of 7%. Please inquire about interest rate changes as dividend rates are declared on an annual basis and loan interests can change on a monthly basis. In our example we are using, the insured / policyowner will repay their college loans by taking loans out of the policy starting at age 23. For the next 15 years, they pay back the college loans and also potentially have money to get started. All distributions will be taken as policy loans with the loan interest being collateralized, and there are no taxes when you withdraw the money (via loans), even at the point where the amount withdrawn is in excess of what was paid in. The key here is to keep enough money in the policy to keep it inforce. And the amount that can be withdrawn will be directly impacted by the dividend and loan interest rates.
Here is one of the differences between this plan and a 529 plan. When you use a 529 plan you are saving money for 18 years and then you would normally spend it down to pay for college. With the 10-pay plan, based upon that original payment of $1,000 a month for 10 years, and after paying back the college loans, there is still enough equity in the policy to provide at age 65, a retirement income of approximately $40,000 a year for 20 years. (Based upon current dividend scale and current loan interest rates, which are not guaranteed to stay the same.)
** The above chart is a hypothetical example that shows the impact of the maturity of money.
When you look at a yield curve above, which is how money grows over time, the older the money is, the more it will grow. By utilizing this concept of a life insurance policy purchased at the child’s age of 5 and paid for over 10 years, you have a policy that continues to grow even after college. You use the money in the policy but you don’t deplete it all and the continued growth will enable you to have the additional retirement benefit. So at age 65, pulling out approximately $40,000 a year for 20 years, you will have pulled out over $1,000,000 to pay for college and retirement, and you will still have cash values and a death benefit. (Click here for an example of how this concept could work.)
This can be an exciting alternative to 529s, one that some people might want to consider. The concept of life insurance for savings is not widely utilized but I think it may make a lot of sense and may provide people with potential for tax benefits and flexibility.
Call me if you have any questions. We would love to show you how this concept would work for you.
* Municipal fund securities are sold by offering statement only, which is available from your registered representative. Please carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about municipal fund securities, please obtain an offering statement and read it carefully before you invest. Investment return and principle value will fluctuate with changes in market conditions such that shares may be worth more or less than original cost when redeemed. Diversification cannot eliminate the risk of investment losses and past performance is not a guarantee of future results.
Michael Fliegelman, CLU, ChFC, AEP, CLTC, RFC
Founder / President, Strategic Wealth Advisors Network
(631) 262-9254
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Please note that the information being provided is strictly as a courtesy. Always confer with your CPA prior to attempting to take any tax deduction. Michael Fliegelman is not a CPA, nor should the contained be considered tax “advice”.
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