Your kids are growing fast. Before you know it, they will be entering college and looking to you for financial support. Because of the spiraling costs, it is even more important to start your college savings plans and contributions as early as possible.
State 529 plans have become one of the most popular methods for college savings, but whole life insurance may be a viable alternative for you. The investment component of whole life insurance offers a more conservative but typically guaranteed investment stream, as opposed to 529 plans that offer more aggressive investments in stocks or stock/bond blends.
During the financial crisis in 2008/2009, some 529 plans took a beating just as the money was needed for incoming freshmen – creating an opportunity for proponents of whole life to pitch the benefits to nervous parents.
Let’s consider some of the relative benefits of whole life and 529 plans.
- Financial Aid Ramifications – 529 plans count against family assets in the considerations for financial aid; whole life insurance plans do not. This is one of the primary arguments insurance salespeople use when pitching whole life plans.
To see how this will affect you, look over a FAFSA (Free Application for Federal Student Aid) application form and try a few quick calculations to gauge how likely you are to receive financial aid and whether the 529 assets will matter.
- Risk/Reward – As previously mentioned, risk is greater with 529 plans – but so is the potential reward. A good estimate for a whole life plan is 2-3% annualized returns. The overall market can beat this, but individual 529 plan holdings vary. Check into the history of the options in available 529 plans for a direct comparison.
- Costs – Both programs have fees associated with them, and whole life plans include commissions. Premiums are higher with whole-life plans, but you receive a life insurance component that does not exist with 529 plans.
Whole life plans cost more in general, but to be fair when making comparisons, you should compare all the costs and contrast them with the cumulative benefits.
- Time – If you have limited time until college costs begin, around 5-7 years or less, you are probably better off with a 529 plan or an aggressive alternative. The investment component of the whole life plan may not have suitable cash to cover college costs until the 7-10 year mark.
If you choose the whole life path, it is extremely important to stick with it. Too many people tire of paying the premiums (or cannot afford them) and end up cashing out before they see the benefits.
- Taxes – 529 plans allow you to withdraw the funds tax-free if they are used for qualified educational purposes. Whole life plans do not have that advantage, but it is possible to get the same effect by borrowing against the cash value. You have to take care in how these loans are structured, and you will incur interest charges.
- Contribution Limits – Whole life plans have no limits, whereas 529 plans have yearly contribution limits and a lifetime contribution limit (varying by state but generally around $200,000-$300,000). For many people, these limits do not pose a problem, but others may prefer the limitless aspect of whole life plans.
Whole life can be a useful alternative to 529 plans or other college savings vehicles, but it is important to start early to get a sufficient return by the time your child is ready for college. Whether whole life is the right choice for you depends on your overall financial situation and your tolerance for risk.
The main takeaway is to research your options, make your college investment choice early, and stick with it. Otherwise, you will be short of funds and 100% dependent on scholarships and financial aid. Do not limit your child’s educational options through poor planning.