Using Life Insurance to Fund College

Nicholas Hoeschel

By Nicholas Hoeschel | August 15, 2017

Saving for college is an excellent strategy, but parents often don’t realize that there are some ways to save that are better than others. There are times when having too much savings can reduce your child’s chances of qualifying for financial aid for college.

In addition to the death benefit protection it provides, life insurance can be useful in helping to fund college.

Unless you are in the top five percent of income earners, there is a good chance that your children will be eligible for financial aid for college. Colleges such as Princeton can cost upwards of $55,000 a year, but few students actually pay that much. Data from the National Center for Education Statistics (NCES) show that Princeton offered an average of $36,918 in scholarships and grant aid in 2014 to first-time undergraduate students. Not everyone attending Princeton that year qualified for that aid, but 62 percent of Princeton students did.

When it comes time to fill out the Free Application for Federal Student Aid (FAFSA) form and the College Board’s College Scholarship Service (CSS) profile, having money in a 529 plan or a large amount of money in a savings or investment account may count against the grants and scholarships your children might otherwise be eligible for. For every $100,000 in savings in the parents’ name above a certain threshold, colleges oftentimes expect around $5,000 of it to be used to pay for college, every year, for every child. If the money is in the child’s name, between 20 and 25 percent of the money is typically expected to be used each year toward college expenses.

The good news is that 401(k), Roth IRAs and other qualified retirement accounts are not part of these calculations. Currently, you don’t have to report them on the FAFSA, and, while the CSS asks about them, they are not considered an assessable asset.

Life insurance is also not considered in the FAFSA and CSS calculations of how much money a family must contribute to the cost of college, which makes it an excellent vehicle for funding college since it doesn’t detract from potential grants, scholarships, and other financial aid.

I meet with a lot of families with children in high school and they are thinking about how they will pay for college. Most have done a good job saving, but oftentimes they don’t understand the impact that savings can have on financial aid. They don’t realize that by putting that money into a whole life insurance policy, they can provide guaranteed protection for their family’s future, utilize the policy’s cash value to help achieve their college funding goals, and they’re not required to include the money for FAFSA and CSS calculation purposes. Permanent life insurance also has the added value of being an uncorrelated asset – its returns are independent of market performance – allowing it to provide guaranteed growth without market risk.

In my opinion, making permanent life insurance the center of a sound financial plan is an excellent strategy at any point in one’s life, and using its cash value as a college funding vehicle can be utilized at any point. But it’s important to keep in mind that life insurance policies have certain requirements and restrictions to keep them in force, and paying too much into a life insurance policy can cause it to become a Modified Endowment Contract (MEC) which can cause loans and/or withdrawals to become taxable. So while this approach for funding college can be used as late as the student’s junior year in high school, perhaps even in college, it’s better to put this in place long beforehand.

Parents of middle school students, or children in the first or second year of high school, are especially good candidates. The earlier they get started the better, as it gives time to build up the cash value of the policy. Brand-new parents and parents of young children might also consider this strategy.

Roth IRAs also offer college savings opportunities for those that are eligible to contribute. Many people don’t know this, but you can take the principle out of a Roth IRA at any time for any reason at any age. So a Roth IRA serves the double purpose of avoiding the FAFSA and CSS calculations while still keeping the money accessible. 401(k) contributions may also provide a vehicle for reducing the family’s assets that may be included in the FAFSA and CSS calculations.

529 plans are designed to offer tax-advantaged college savings options. 529 plans aren’t as flexible as Roth IRAs or life insurance, as the money can only be used for educational purposes but they do offer the flexibility that the owner of the 529 plan can change the beneficiary at any time without penalty.

I invite you to talk to a financial adviser about the right strategy for your own circumstances. There’s no right answer for choosing one college savings vehicle over another, as they all have their purposes. The key to a sound strategy is flexibility because needs and circumstances can, and oftentimes do, change.

All guarantees are based upon the claims paying ability of the issuer. Accessing cash values may result in surrender fees and charges, may require additional premium payments to maintain coverage, and will reduce the death benefit and policy values. Loans and other policy withdrawals may be taxable under certain circumstances.


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  • Bob Falcon says:

    Good points about the Roth IRA. However, income has about a 9X impact on financial aid over assets. Many folks with assets large enough to significanly impair needs-based financial aid also have large incomes, so sheltering $500K of assets with life insurance might lower EFC by $25,000, but if income is drving a $100,000 EFC, lowering it to $75,000 won’t result in a dime of needs-based financial aid. Finally, cash value life insurance is not necessarily excluded for college, as some CSS Profile school specifically ask for this information.

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