THE UNIQUE COLLEGE SAVINGS PLAN YOU'VE PROBABLY NEVER HEARD OF
529 savings plans. Bank savings accounts. Stocks and mutual funds. With so many ways to save for college for your kids, how do you know you're choosing the right combination? And are you missing out on this unknown savings tool?
When you hear the words “life insurance,” your thoughts probably turn to death and funerals. You wouldn’t be wrong in assuming the main reason most people own life insurance is to pay for final expenses and funerals.
In fact, 53 percent of people who own life insurance cite the need to pay for final expenses as a major reason for owning a policy.
But life insurance is a tool that can serve more purposes than only paying for final expenses.
Children’s life insurance, especially, can be utilized to help pay for future college expenses in addition to providing sufficient life insurance coverage. We'll explain how, but first, let’s talk about some of the different options and tools you can use to put an effective plan together.
Understanding how more traditional college savings options work will help you decide if children's insurance is a good savings tool for your child.
WHEN SHOULD YOU START SAVING FOR COLLEGE?
With a kid (or two...or three…), 18 years might feel as if they fly right by. Before you know it, your baby is an adult in a cap and gown about to head off to college.
You can help pay for the cost of attending college by saving as early as possible.
Of course, saving for college probably isn’t your highest priority while you’re struggling with diaper changes, long nights with little (or no) sleep and lots and lots of crying.
But the earlier you can start saving for your child’s college fund, the better.
According to CollegeBoard, the average cost of attending an in-state public college in 2017 is $9,650 per year. Out-of-state students would need to pay $24,930 per year at the same college.
A private four-year college costs a whopping $33,480 per year.
The kicker? None of these costs include room and board fees, which would add another $10,000 or so to the yearly cost of attending college.
As you can see, and probably already know from experience, college can be an expensive (though worthwhile) endeavor. The earlier you start saving, the more money you’ll be able to give to your child to help pay for tuition at whatever school they decide to attend.
In some cases, those savings can even help contribute to starting their adult life.
WHAT ARE SOME DIFFERENT COLLEGE SAVINGS OPTIONS?
There are a few different ways to start saving for your child’s college education. Of course, whatever choice works best for you depends on your family’s financial situation and how much you choose to put aside to help fund future college plans.
In fact, a report by Sallie Mae shows that most parents save through a combination of different plans. That way they can balance the advantages, risks and downsides of each to help pay for their children’s college.
Bank savings accounts
As is the case with most major financial goals, an ordinary bank savings account works just fine when saving for your child’s college education.
Bank savings accounts generate interest on the money you deposit. Over time, the interest builds on your overall contribution to your kid’s college fund.
Some banks even offer special college savings accounts. These types of accounts may offer an added bonus or perk for your child upon turning a certain age — usually 18 — and are intended specifically for financing a college education.
Savings accounts meant for your child’s college fund should have your child listed as the beneficiary (the person who would receive the money upon your death).
Naming someone as a beneficiary will protect the savings account from being tied up in the lengthy probate process.
Savings in your child’s name may have a negative impact on their potential for qualifying for financial aid. While some of your income and assets are protected from impacting your child’s financial aid eligibility, assets in their name are not shielded.
And while bank savings accounts generate interest, the interest rate is often quite low. As of July 2017, the average interest rate is .06 percent according to the FDIC.
What’s all that mean?
When applying for financial aid through FAFSA, you must report your assets and income (minus the amount protected by the asset protection allowance). Your child must also report his or her savings and income.
A bank savings account with your child as beneficiary could then reduce some of the needs-based financial aid your child is eligible for. Since some financial aid comes in the form of free money, such as grants and scholarships, it’s important to get as much as he or she is eligible for.
A 529 plan, or qualified tuition plan, is a savings plan designed to help you save for future college costs.
529 plans are sponsored by states, state agencies and educational institutions. They offer tax benefits to saving and using the savings to pay for college.
Interest on contributions made to a 529 plan aren’t federally taxable. They also may not be subject to state taxes, as long as the savings are used to fund college expenses. Using savings for a purpose other than college would subject you to a penalty.
Two types of 529 plans exist, with each state supporting at least one type.
Prepaid tuition plans
Prepaid tuition plans allow you to purchase units and credits at certain colleges. These units represent tuition and even sometimes room and board and help lock in the cost of tuition.
Prepaid tuition plans often require you to be a resident of the state sponsoring the plan.
Payments made toward a prepaid tuition plan are put into a pool of money that’s then invested by the state or sponsoring agency. These investments help ensure that the cost of tuition will be covered even as it rises over the years.
States often guarantee the funds in a prepaid tuition plan. As such, the plan will never be in jeopardy of not paying for your child’s college education.
College savings plan
Unlike prepaid tuition plans, you can contribute to a college savings plan no matter which state you live in or which state your child will attend college in. Of course, a college savings plan based in your home state may offer you certain tax advantages, such as tax-free interest.
College savings plans pay for more than just your child’s college tuition, too. The savings can be applied to any college expenses, including tuition, room and board, book costs and other fees.
Where a prepaid tuition plan is the purchase of credits that lock in the cost of attending college, college savings plans offer no such promise.
College savings plans are investment vehicles, meaning you can choose the different investment options the plan will use in order to grow.
Generally, a college savings plan will invest in aggressive and higher-risk stocks in the beginning, tapering down to more steady and conservative bonds as your child approaches college age.
As college savings plans are forms of investing, they’re not backed by the state. Additionally, it is possible for you to lose some of your investment over time. There are also management and sales fees, similar to other types of investments.
Like with prepaid tuition plans, earnings from a college savings plan aren’t subject to federal (and sometimes state) taxes. There are no penalties for withdrawing funds as long as they’re used for college expenses, either.
Stocks & mutual funds
Stocks and mutual funds function similarly to a college savings plan, with the exception of tax-deferred and tax-free growth.
While a 529 plan may limit what investments you may make and how often you can make changes to your portfolio, stocks and mutual funds give you far more control and freedom over how you invest.
There’s also no limitation for how you can use your investment earnings. If you wind up saving more money than expected over time, or your child attends a low-cost college, you can use the remaining money as part of your retirement, for home improvements or even for a nice vacation.
(And after 18 years of raising a child, you’ve surely earned a relaxing little vacation.)
While you’re responsible for paying management fees and taxes on your investments, you’re given more freedom over how they’re made compared to a 529 plan. Your portfolio can be as aggressive or as conservative as you’re comfortable with.
When it comes time for your child to apply for financial aid, stocks and mutual funds will have an impact on needs-based financial aid eligibility.
Children’s life insurance plans
We understand your initial confusion if you’re asking yourself, “How does life insurance for my child help pay for their college?”
While the main intent of purchasing life insurance — as an adult, at least — is to cover debts and final expenses, you can establish a child life insurance college fund by purchasing a policy for your children.
Most life insurance for children comes with a death benefit of anywhere from $5,000 to $50,000 and can cost as little as $3.50 to $33.65 per month.
It’s possible to provide life insurance for your children with a rider attached to your own policy. But this type of life insurance is usually term life.
Term life provides a cash payout if your child were to die within the term, but that’s the only benefit of this sort of rider.
The type of life insurance that will not only insure your child’s life but also provide a means to fund a college education is whole life insurance. Whole life insurance builds cash value that you can use to help pay for college.
Child life insurance cash value
Children’s life insurance is whole life insurance designed specifically for children. You can purchase a policy when your child is as young as a few days old to well into their teens.
Of course, the earlier you purchase a policy, the more time the cash value has to grow.
Cash value is what allows the policy to serve as a child’s life insurance college fund. As you pay the policy’s monthly premiums, a portion of those premiums will be set aside. This represents the “cash value” portion of the policy.
It’s possible to use the cash value of a child’s life insurance policy in the same way you would with an adult whole life policy. This means you can surrender, or terminate, the policy in exchange for a payout of the accumulated cash value.
You may also use the cash value to take a loan out of the policy. This would reduce the death benefit by the same amount as the loan until it’s repaid, but give you cash in a pinch.
If you run into financial difficulties and can’t pay the premiums for a bit, the accumulated cash value may be used to keep the policy in force until you continue making payments or the cash value runs out.
Using child life insurance cash value to pay for college
When the time comes to pay for college, you or your child can decide to use the accumulated cash value of his or her child life insurance policy to help with the costs.
And guess what?
Unlike the other options we’ve covered, life insurance policies don’t need to be reported on a FAFSA application. As a result, there’s no impact on your child’s needs-based financial aid eligibility.
The cash value of a life insurance policy can be used for any reason or purpose, too.
Surrendering, or cashing out, your child’s life insurance policy could give them a head start on beginning their college career or adult life.
Some insurers offer life insurance products that will mature when your child reaches a certain age, usually 18 or 21, and pay out a guaranteed payment. This payout can be used to pay for your child’s college while ensuring they’re covered by life insurance throughout childhood.
WHY BUY LIFE INSURANCE FOR CHILDREN?
Life insurance for your child serves multiple purposes. If the worst thing imaginable happens, final expenses for your child are covered.
But purchasing life insurance on a young and healthy child guarantees their future insurability, too. This means if your child develops a disease or condition that would disqualify them from purchasing life insurance in the future, or that would make the premiums unaffordable, they can still purchase more without going through the underwriting process.
Children’s life insurance policies don’t end upon reaching adulthood, either. As long as the policy’s not surrendered and premiums are still paid, the life insurance will follow your child throughout their life.
Some insurers will even double the amount of coverage when your child turns a certain age, usually 18. This means a $10,000 policy purchased when your child was just a few weeks old becomes a $20,000 policy upon reaching adulthood.
Premiums never change with children’s life insurance, either. A $10,000 plan you purchase when your child is under a year old could cost $7.00 per month. When your child’s 18, that same plan would continue to cost $7.00 per month.
Children’s life insurance works as an excellent “forced savings” as well. Since your monthly premiums contribute to the cash value, you’re growing savings while keeping the policy in effect.
That cash value can then be used by your son or daughter for any number of reasons, including college expenses.
Purchasing life insurance for your children is a way of protecting their young lives while helping them get a head start on their adult lives down the road.
HOW DO I DETERMINE WHICH COLLEGE SAVINGS PLAN IS BEST FOR MY CHILD?
As with most major financial decisions, the best path to take to help your child afford college is whatever makes the most sense for your personal financial situation and risk tolerance.
None of the options we’ve discussed are without drawbacks and each one helps your child pay for college in a different way.
When deciding which savings plan is right for your child, you need to consider:
- The tax benefits and consequences
- Your acceptable risk level
- The impact on needs-based financial aid eligibility
- Alternative uses for the plan
THE PROS AND CONS OF DIFFERENT COLLEGE SAVINGS PLANS
SAVINGS PLAN TYPE
Bank savings account
Easy to set up
Interest is taxable
Interest rates are low
Prepaid tuition plan (529 plan)
Federal tax benefits, usually state tax benefits
Locks in cost of tuition at participating colleges
Tax-free if funds are used for tuition
Usually guaranteed by the state; no investment risk
Only covers tuition (and optionally room and board), not other college expenses or fees
Withdrawals for non-college expenses are subject to a penalty
Can have a negligible impact on needs-based financial aid
College savings plan (529 plan)
Federal tax benefits, usually state tax benefits
Tax-free if funds are used for college costs
Can be used to pay for all college expenses and fees
Can be used to pay for any college, regardless of residency
Withdrawals for non-college expenses are subject to a penalty
Are an investment vehicle and subject to investment risk — can lose money
Limited on investment options and frequency of changing options
Not guaranteed by the state
Can have a negligible impact on needs-based financial aid eligibility
Stocks and mutual funds
Freedom and control over how investments are made
Can be used for any purpose, not just college expenses
Associated risk with investing — can lose money
Management fees and taxes
Has an impact on needs-based financial aid eligibility
Children’s life insurance
Provides life insurance benefits for your child’s entire life
Accumulates cash value
Cash value can be surrendered for a payout
Cash payout can be used for any purpose, including college expenses
Low monthly premium
Level premiums that never increase
Coverage may double at a certain age
Must continue making payments to keep the policy in force
Surrendering the cash value will leave your child without insurance
No impact on needs-based financial aid eligibility
As the Sallie Mae report highlights, most parents save for their children’s college education in a combination of ways. While there’s no one perfect solution, determine what combination works best for your financial situation.
Consider, too, the importance of life insurance for your children. Children’s life insurance serves a dual purpose in that it provides a death benefit for the unspeakable, but also an excellent forced savings opportunity that can help pay for college.
What if your child doesn’t need to use the cash value to pay for college? Perhaps he or she has worked hard and earned enough scholarships to pay for an entire four-year college education.
Well, they’ll still be covered by a whole life insurance policy that will aid them at every stage of their life, serving as a reminder of your foresight, careful planning and undying love.
No matter which option or combination of plans you choose, saving for your child’s college education is a tremendous gift.