IUL for funding college? If you have a client in the market for life insurance, they may be surprised that it may help them save for a child’s — or grandchild’s — college education.
Obviously, life insurance is first and foremost purchased for its death benefit. But we’re going to focus on one of the many living benefits of an IUL. We all know college is increasingly expensive. The Education Data Initiative estimates Americans owe a mind-boggling $1.75 trillion in student loans, second only to mortgages as the largest household debt.
While clients typically view 529s as the gold standard when it comes to putting away money for college, it’s not the only path that offers tax benefits. Another option is to take out a permanent life insurance policy which can have a tax-deferred savings component.
Here are 7 good-to-know facts for funding college with IUL:
Say Junior doesn’t want to go to college — now what? Better yet, what if your clients’ bright star gets a full scholarship?
With a permanent (whole life) insurance policy, the built-up cash-value can be used for a tax-free loan to finance ANY expense. Like living expenses around campus. Or a deposit on a condo. Or let the cash-value compound and use it at a later date.
In a 529 plan, your client will either have to pull money out and pay income tax, a 10% federal excise penalty if the money isn’t used for qualified educational expenses, possible back taxes on any state tax deductions, or transfer the plan to another student.
2. OVERSEAS OPPORTUNITY
Congratulations! Junior got accepted to a prestigious school in Europe. Bummer your client may not be able to use their College Savings Plan outside the USA. To qualify for using a 529, the institution abroad must be eligible for Title IV federal student aid.
But the built-up cash value from a permanent life insurance is still available for use no matter which school, or country, your client chooses.
3. FINANCIAL AID GAME
We all want to get the best value for our hard-earned buck. Higher education is often expensive. A robust 529 could hurt Junior’s chances at tapping sources of financial aid. When colleges assess parental assets for a student who is applying for federal financial aid, a 529 plan must be reported. Good thing your client purchased an IUL.
One of the major advantages of using a cash value policy for college savings is that money in an insurance policy won’t reduce eligibility for financial aid. Money in a 529 college savings plan can subtract up to 5.6 cents in aid for every dollar stored in the account, but cash value life insurance policies are sheltered from the federal financial aid formula, according to the Department of Education.
“If families take money out of a life insurance policy for college, they need to do that as a loan,” says Jim Van Meter, founder and president of The College Planning and Funding Advisor in Reno, Nev.
Van Meter goes on to say that taking a loan against a life insurance policy won’t count against financial aid but will reduce the death benefit if not repaid. Cashing a policy out entirely will count as income and can reduce your aid package by up to 47% and could incur surrender charges.
4. POTENTIALLY LOWER-RISK
Dwayne Burnell, a Seattle-based financial advisor and co-founder of the financial advice website FinancialBallGame.com, is a proponent of using life insurance to help save for college. He typically recommends using whole life policies for this purpose.
“You don’t know how much your 529 is going to be worth at any point in time, especially when you need it,” Burnell says, whereas a whole life policy may be able to provide steady, more predictable growth because of its guaranteed interest rate feature. “When clients purchase this policy and fund it properly, they don’t have to worry about whether it will be there at [age] 18. It helps reduce the worry factor.”
5. GUARANTEED INTEREST
While a 529 might make more sense for some investors because of the potential for strong returns, the downside is the potential for low, even negative, returns. Conversely, whole and universal insurance policies frequently provide guaranteed interest credits, which really add up over a lifetime, but can be a hindrance if there’s a specific goal that has to be met over a limited time.
Myron Feinberg, a Certified Financial Planner and founder of the College Aid Specialist on Commack, NY, agrees, “While other investment plans may fluctuate with the market, whole and universal insurance policies frequently provide guaranteed growth potential if time is on your side.”
6. UNINTERRUPTED COMPOUNDING
Another key advantage of using life insurance to help save for college, Burnell says, is a provision known as “uninterrupted compounding” that allows money in a cash-value policy to continue to grow even if the policyholder takes out a loan against it. So, if you have a policy with a $70,000 cash value and take out a $40,000 loan against it, your policy will continue to earn interest based on that $70,000. “It’s the only product on the planet that has that feature,” Burnell says.
Of course, clients’ will have to pay interest on the loan, and if that interest rate is greater than the one received on the cash-value policy amount, the strategy probably doesn’t make sense. In addition, if you take out too large of a loan over time or don’t fund the policy properly, it could lapse and offer no coverage at all so you need to structure the policy correctly and manage it over time.
7. FLEXIBILITY. AGAIN.
“With life insurance, it doesn’t matter how you use the cash,” says Jim Van Meter. A student can use life insurance savings for college, a down payment on a house, to start a business, or for retirement, he says.
So with all that being said, here are some concluding thoughts:
Do your homework to make sure an IUL fits your clients’ needs. Review restrictions and read the fine print. Know that, as with anything, returns may not keep up with college inflation costs.
Be aware that life insurance is a long-term product designed first and foremost for its ability to offer a death benefit. There are significant fees and charges to cover the cost of insurance, so your clients must have a defined need for the life insurance it provides, and be aware of potential surrender charges.
Life insurance typically requires medical and sometimes financial underwriting to qualify. Life insurance guarantees are backed by the financial strength and claims-paying ability of the issuing company. Product and feature availability may vary by state.
Lastly — and most importantly — work with an IMO like DMI.
Join Nationwide & DMI on May 11th as we talk about Student Loan Debt Management Strategies including:
• Types of federal student loans
• Non-income driven repayment plans
• Income-driven repayment plans
• Forgiveness programs
• Deferment, forbearance, & default
Then learn the ABCs of using cash value life insurance for a child’s higher education.
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