Today, the cost of higher education has continued to skyrocket. In fact, in many areas, the tab on getting a 4-year college degree can be in excess of six figures. With this in mind, many parents begin saving early in their child’s life.
As with anything, it only makes sense to start saving for college when children are young. One reason for doing so is the effect that compound interest has on the growth of those funds that are being saved. Over a period of 10 or 15 years, funds can grow substantially, essentially helping to at least pay for some – if not all – of your child’s future educational expenses.
All College Savings Plan Options Aren’t Created Equal
When setting up a plan to save for future education costs, many people look at options that will allow growth, yet safety. In many instances, parents are seeking that fine line between growing the funds, while also hoping to reduce the taxable effects.
For example, in most cases, interest that is earned in taxable investment accounts is considered taxable income on the federal and the state level – and because of this, taxes will be incurred, which will essentially lessen the growth that is ultimately received on that savings.
Unfortunately for most investors, taxes must be paid either from current income, or from money that is withdrawn from other sources. Either way, however, the result is essentially the same. Therefore, the structuring of a more efficient college savings plan is likely needed.
Why Life Insurance Makes Sense as a College Savings Vehicle
While most people may not realize it, whole life insurance can make for an ideal funding vehicle for a college savings plan. There are actually a couple of ways in which plans can be structured in order to fit certain situations. Either way, however, the child is assured of the funding that is needed for him or her to attend a higher education institution.
First, by putting a life insurance policy on the life of the child, the funds that are in the cash value component of the whole life insurance policy can provide both tax sheltering, as well as flexibility in terms of how the money may be used.
When a child is initially born, the parents may opt to take out a life insurance policy on him or her – provided, of course, that the child is in good health and will be able to qualify for the coverage.
Even a policy with a relatively large face amount can typically be purchased for a small amount of premium. In most instances, the child will be able to be placed on the policy as the insured, while the parents can be listed as both the policy owners and the policy beneficiaries.
As the premium payments are made into the life insurance policy, the investment income that is generated by the cash value component will not be subject to current income taxation. Therefore, this cash value can continue to grow and compound.
When the time arrives for the child to attend college, there will be a couple of different options. One would be to cancel the insurance policy and withdraw the cash, using it to fund the educational expenses.
Alternatively, the policy may be kept in force, and the funds that are needed for college costs can be borrowed from the policy’s cash value. Although this will incur a policy loan, it will also keep the life insurance coverage in force.
In lieu of – or in addition to – placing a life insurance policy on the life of the child is the strategy of putting a policy on the life of one or both parents. With this method, the child would be named as the policy’s beneficiary.
If this is the case, should the parent pass away, the child’s college education would still be assured of funding, as the proceeds from the policy could be used for this purpose. This strategy, however, would also require that an additional savings take place.
Therefore, provided that the policy was purchased while the child was quite young – with at least 10 to 12 years before the attendance of college – the cash value in the policy would have time to build to a substantial enough level that it could be used to fund some or all of the child’s college expenses.
There are many advantages to using life insurance when funding a child’s future college education costs. While other options such as stocks and mutual funds may provide potentially higher growth, these vehicles also expose the investor to potentially more market risk, without the added death benefit protection should the unthinkable occur.