Choosing A College Saving Plan
Is Life Insurance a Good Alternative?
What is the best type of college saving plan? Although there are many advantages of 529 accounts, saving money for college using a life insurance policy may be a better alternative for some families.
Saving money for children’s college education is one of the most significant financial challenges that face families today. A college saving plan can represent a large commitment of financial resources, rivaled only by paying for a home and saving for retirement. One popular type of college savings account is the Section 529 plan.
What is a Section 529 Plan?
A Section 529 plan is a tax favored account designed to encourage saving for college. Also known as a qualified tuition program, it derives its name from the section in the Internal Revenue Code that defines the plans. There are actually two types of 529 accounts: prepaid tuition plans and college savings plans.
A 529 prepaid tuition plan allows a family to pay for all or part of a student’s future tuition costs at today’s prices. Since tuition costs normally rise faster than the overall rate of inflation, this type of plan is attractive to families who want to lock in rates and not be concerned about rising prices or the need to achieve a high rate of return on investments.
A 529 college savings plan allows a family to save money in an account designated to be used for college costs. Similar to an IRA, this type of college saving plan usually offers a number of investment options and the value of the account increases or decreases based on the performance of the investments.
529 Accounts – Taxes and Federal Student Financial Aid
The main advantage of the 529 accounts is that there is no federal tax on the earnings or distributions as long as the funds are used for qualified education expenses. This can be a significant benefit for a family depending on their tax bracket. However, if the money is used for something other than education costs, the earnings are taxed and also subject to a 10% penalty.
For college financial aid purposes, distributions from 529 accounts owned by the parents or children are not counted as income on the FAFSA form. However, the value of the account is counted as an asset on the FAFSA form. This means that a maximum of 5.64% of the value of a Section 529 plan owned by parents may reduce need-based financial aid for their child.
Although a Section 529 college savings account is a great option for many families, there are reasons why it may not be the best alternative for everyone. Consider, for example, a family with a limited income who wants to start saving for their newborn’s education. They don’t have a reliable way to predict how much of their resources they can devote to education for the next eighteen years. A 529 account may not be flexible enough for them.
Life Insurance – A Flexible College Saving Plan
Permanent life insurance policies such as whole life, universal life, and variable universal life can be used to save money for college. Over time, as premiums are paid into these policies, they can build up cash value. The cash value is not counted as an asset for federal student financial aid purposes.
The accumulation of the cash value of the insurance is tax deferred. The cash value can be accessed via loans or withdrawals to help pay for college when needed. If done correctly, taking money out of the policy can be done on a tax free basis. These distributions are not counted as income on the FAFSA form.
Life insurance is flexible in that the loans and withdrawals can be used for any purpose without restriction. If a family intends it for a college saving plan but then needs some of it for another purpose, there is no penalty. Also, an obvious benefit of life insurance is that if the insured person dies, the beneficiaries receive a death benefit.
Saving money for college is a complex subject. In addition to the ideas presented here, there are many options and factors to consider when setting up a college saving plan. It may be wise to consult a professional who specializes in college financial planning to assist you in making the best descisions.
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