Saving for College: 529 vs. Life Insurance

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Important things to know...
  • The 529 plan for saving for college is a time-tested method of accumulation and is available in all states. The money in a 529 is not deductible, but the earnings are not taxed as the money accumulates
  • The investments that are available vary from state to state, and they are largely based on mutual funds, bond funds, and exchange-traded funds
  • Life insurance can be used as a very sound college savings vehicle. It is possible to emphasize the cash accumulation factors of the whole life with dividends or equity indexed universal life policies
  • Life insurance has some distinct advantages in fewer costs and fees, along with easier access to the money at all times compared to limited access in the 529 plans

A 529 Plan is a savings plan for college sponsored by the states and educational institutions in America. The plan is named after Section 529 of the IRS code, and it allows individuals to set aside funds for the future education of a named beneficiary.

The 529 plan is set up to work through participating colleges and universities throughout the country. There are no restrictions regarding where a plan is set up and begun abo where a school is located.

A donor can be a resident of one state and invest in a plan in a different state, and yet the student can attend college in an entirely different state. This allows freedom in shopping for the best plan, and yet the student can attend any college he or she chooses.

Funds that are placed in the 529 plan are not deductible for the donor, but the earnings on deposited money accumulate free of federal income taxation.

When the money is removed from the plan for college expenses, those funds are also not taxed. Most of the plans use mutual funds and exchange-traded fund for the vehicle used for investments.

It is important that the donor understands the various funds and their objectives and act accordingly regarding his or her investment objectives. This can lead to success.

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529 Investors Should Understand the Fees


As attractive as 529 plans appear to be, only 3 percent of Americans use this method of accumulating money for college. The average American finds the plans to be overly complex, risky and expensive.

In 21012 the GAO discovered that some 529 plans charged as much as 2.78 percent of the assets of the fund each year. This much in expenses could reverse any tax savings, not to mention that the entire amount of money is at risk in the stock market.

The donor to the 529 plan should thoroughly investigate the fees and find investments that have the lowest fees.

There is information available as to which funds to pick in this category.

The factor of risk apparently plays a big role in the decision of consumers regarding the use of a 529 plan at all.

It is one thing to be able to capitalize on big gains in the stock market, but the possibility of a big fall in the market is always there, such as in 1987 and 2008.

If your student is ready to pull the money out of the 529 plan and a severe downturn occurs, it occurs that a savings account would have been a better choice.

529 plans can be an excellent vehicle for a plan to save money for college for a child or grandchild. If a donor puts forth a good effort in due diligence in the area of fees, and they feel they have a good grasp on the risk factors of the market it can work.

It is important to get a plan with low fees, and have an investment philosophy that the donor can control.

Using Life Insurance as a College Savings Vehicle

With many people, life insurance would not be a choice for a savings program for anything. However, when managed correctly and designed properly, life insurance is the best choice for a college savings program.

The design could be either a whole life policy purchased from a mutual company that pays dividends, or it could be an equity-indexed universal life policy, based on the S&P stock index.

With the policy purchased through the mutual company, the dividend option chosen would be the paid-up additions option, and a paid-up additions rider would also be included in the mix to maximize the cash savings to the max.

For the indexed universal life policy, the policy would be pre-funded to the maximum must short of the policy becoming a modified endowment contract or an MEC.

Life Insurance Comparison to 529 Plans

  • Market Risk – A big factor with either life insurance choice is that there is no market risk on the funds that are put into either life insurance account. The input of money into the plans will result in annual increases on a regular basis. Both plans can be pre-funded to the max with no limitation regarding a funding ceiling. There are funding limitations with 529 plans.
  • Control of the Money – The money in either life insurance plan is completely under the control of the insurance policyholder, and can be used for any purpose. The 529 money must be used for education. Perhaps the student receives a full scholarship for his or her entire college career and the money could be used to buy a house or a vehicle. Flexibility is a great asset regarding a life insurance plan.
  • Fees and Penalties – Both the 529 plan and the life insurance plans have the advantage of a tax-free buildup of the funds, meaning that there will be no Federal income tax on the earnings while the money is in the plan. The 529 plan also does not tax the money if it is used for education, but the money will be taxed if funds are used for other purposes. There is a 10 percent surtax if the money in a 529 plan is taken out prior to the student attending college.
  • Access to the Money – Money in the life insurance plans can be borrowed from the life insurance policies and there is no tax at all on these transactions. After all, the student may decide not to go to college at all, and a 529 plan would be inappropriate. Using the money for other purposes would be costly.
  • Death Benefit – The life insurance plan has a tax-free death benefit over and above the amount of cash funds available, whereas the 529 plan’s death benefit is limited to the amount of the funds in the account.
  • Disability of the Donor – The life insurance plan has a disability waiver of premium where the deposits are made in the event of the donor’s disability. The 529 plan has no such provision.

In Conclusion

The life insurance method for saving money for college has many advantages over the 529 plan. While the prospect of higher earnings in the 529 plan is evident, there is also the risk of losing money if the stock market decreases.

The life insurance plan has the advantages of fewer costs, fees and greater ease of having access to the funds anytime.

The death benefit and disability of the life insurance are other very positive factors for the life insurance method.

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