Spoiler alert: College costs are high and rising. Funding a college education is a bigger-than-ever expense for most families. Sure, grants, scholarships, and 529 plans can help cover some costs. But even then, you may need additional funding to pay off the bill completely. Instead of turning immediately to loads of student loan debt, there is an option to help fill this gap that many people overlook – using life insurance to pay for college.
How do you use life insurance to pay for college?
More than 51 percent of Americans were unsure or didn’t believe that cash value from life insurance could be used to pay for college, according to Allianz Life’s 2018 Life Insurance Needs Survey. Most people buy life insurance to provide a death benefit for their loved ones. However, cash value life insurance lets you build cash value, which you can access through policy loans or withdrawals for anything you choose – including funding a college education.
With fixed index universal life insurance (FIUL), your policy will earn interest based on the positive performance of an external index but will never decrease due to market volatility. A FIUL policy doesn’t directly participate in the market, which helps reduce risk. This gives you the opportunity to participate in market upturns but not downturns, which is a great feature when saving for college because market losses can devastate your saving-for-college plan. Because of the short time you have to save for college – 18 years at best – there isn’t time to recover from drastic market losses.
Tax benefits of using life insurance for college funding
There are three tax benefits of using FIUL to pay for college:
- Income-tax-free death benefit to your beneficiaries.
- Tax-deferred cash accumulation.
- Income-tax-free policy loans or withdrawals for college and retirement, or whatever else you choose.
It’s always smart to look for ways to help reduce your tax liability as soon as possible.
How does it work?
You take an indexed loan against your policy for an annual up-front interest charge that’s locked in when you purchase your policy. Your policy will keep earning indexed interest on both the un-loaned and loaned values. This means the potential credited indexed interest could offset the annual loan interest charge. You use the money from the loan to help foot that extensive college bill and work to repay the loan over time.
The policy continues to earn indexed interest and the cash value continues to grow. Then, in retirement, you can again access the cash value in the form of a tax-free income stream. This makes FIUL a great strategy for both college and retirement. It’s an ideal alternative for those families who are over the income threshold for Roth contributions.
What’s the catch?
There are a few things to keep in mind when using life insurance to pay for college:
The loan can’t exceed the total cash value of the account. If it does and you don’t add more money to the policy, you could face a lapse. A lapse could cause unfortunate tax consequences.
If you die before you repay your loan, the death benefit of your policy is reduced. Obviously, that wouldn’t be ideal for your family while they deal with an already difficult situation.
Be sure to consult a financial professional who is qualified to help you minimize potential income tax, gift tax, and estate tax consequences.
Learn more about Knowledge4College to get help on college finances for your family.