The Gerber College Plan is issued by Gerber Life, a small life insurer based in NY that specializes in various small cash value life insurance plans targeted as savings plans the old school life insurance savings plan way. Gerber has a relatively aggressive marketing plan that uses TV and direct mail to bring its message to Americans all across the country. They are especially good at targeting new parents–taking a page from the old life insurance selling play book.
Today I'm going to help you sort out whether or not this plan is worth your time and money.
First, the Pitch
Let's first understand what the Gerber College Plan is. It's a cash value life insurance policy positioned as a means to save for college. You choose the death benefit amount and duration (10 or 20 years) and Gerber guarantees that your policy will be worth the death benefit amount at the end of the selected duration. If you die in the mean time, Gerber pays the death benefit, which completes the savings plan for you. Sounds cool.
Wait a Minute…
If you've wandered around the Insurance Pro Blog for a while, or if you've happened upon the Whole Life post, that description above might sound familiar.
We've perfectly described an endowment contract. Note: not a modified endowment contract or MEC, but rather a true blue endowment contract.
Endowments were really popular savings vehicles up until the passage of the Deficit Reduction Act of 1984 (DEFRA) and the Technical and Miscellaneous Revenue Act of 1988 (TAMRA). These legislative actions established life insurance qualification tests (DEFRA) and the Modified Endowment Contract 7-Pay Test (TAMRA).
The more serious fatal blow was delivered by DEFRA. The Cash Value Accumulation Test (CVAT), the test used to qualify all non flexible premium life insurance contracts, will not allow the cash value inside an endowment that would be required for the endowment to work. For this reason, the issue of endowments as new business in the United States has pretty much disappeared.
So how does Gerber get around this?
The Gerber College Plan is an endowment contract, and it violates the Cash Value Accumulation Test. The interesting thing is that life insurance companies don't usually issue life insurance policies that immediately fail the qualifying life insurance test at policy issue.
Gerber appears to be the exception.
Because the Gerber plan fails CVAT and is immediately re-classified as an investment, the policy loses its tax deferred status on gains, which Gerber is very upfront about. Here's a snapshot of a disclosure on their information page:
Now, ignoring their very misleading explanation about why it's being taxed. There are a few issues here they've completely failed to mention.
Life insurance contracts that fail a qualification test and are reclassified as investments have different rules for the treatment of death benefits.
Only the amount above the cash surrender value is considered a life insurance death benefit. The remaining amount is treated as a transfer of an investment and is subject to prevailing laws regarding such transfers at time of death.
In addition, these policies are taxed based on “income on the contract,” which is defined by the IRS as the increase in cash value and the cost of providing the life insurance coverage minus the premium paid. Meaning you pay taxes not just on the increase, but also on the cost of providing the death benefit.
The tax deductibility of a 529 is is only allowed in certain states and that deductions is for State Income Tax (not Federal Income Tax). But this alone isn't the only problem.
There's way more to consider here than just the five items Gerber has listed. This is an old marketing framing trick.
I can make anything look good or bad, depending on how I present it (everyone does this).
This table fails to consider: tax deferral, contribution limits, and financial aid considerations (the Gerber College Plan would likely be recognized on the FAFSA just like the 529 as an asset held by the parent as it's not a life insurance contract, but an investment account due to it's failure of the DEFRA test).
On top of that, it's neither accurate nor fair to suggest that no stock market risk is something one cannot achieve with a 529 plan. There are some plans that place assets completely in Bonds and cash.
The Gerber Plan, should you Buy in?
The answer is probably not.
But that's not because you should use a 529 plan or your bank savings account instead.
There are benefits to using cash value life insurance products for college funding. However, it makes no sense to use a life insurance policy that has lost it's status as a life insurance contract.
Looks impressive. However, read the text to the right of the picture. Gerber admits this isn't a real policy, it's just a hypothetical example of how policy growth could look.
Let's use Real Life Contracts to get the Job Done
If you want to really save for college, don't waste your time on the Gerber Plan. You've been fooled if you think the $4 a day Gerber tells you it will cost–will put any significant dent in the overall college cost.
Real life insurance can work, and can do a far superior job compared to the Gerber Plan. Here's an example of a participating whole life policy compared to Gerber's $6 per day example of a healthy 25 year old female.
At $6 per day (or $2190 per year–ignoring Leap Years) Gerber will give us a $30,000 death benefit and a guaranteed cash value after 18 years of $30,000.
My graph doesn't look that impressive, but that's because I'm not blowing up tiny numbers (i.e. I have a lot wider range I need to deal with regarding cash value and death benefit).
On the whole life side, we start with a $275,000 death benefit and after 18 years we're guaranteed to have just about $46,000 in cash value. The death benefit 18 years down the road is guaranteed to be at $408,000. Now, that in and of itself is considerably better than the Gerber plan.
But what happens when we throw dividends into the mix?
Whole life as an asset really only works well if we use participating policies.
And dividends make a big difference. When we introduce dividends to this example (the green and purple lines above) projected values for year 18 are $62,000 in cash surrender value and $447,000 for death benefit.
We get way more bang for our buck on the whole life side vs. the Gerber plan.
Let's consider some additional benefits.
The cash surrender value is not taxed as an investment because the whole life policy hasn't violated the DEFRA test, meaning its cash grows tax deferred. The death benefit is income tax free as it's bona fide life insurance contract.
The contributions to this policy are not limited by the original chosen premium. This is a blended and over-funded policy making significant use of paid-up additions–meaning we can adjust the outlay up or down if we choose.
Life insurance cash values are not currently included assets for financial aid eligibility on the FAFSA. Meaning even better than the parent ownership treatment of a 529 plan or parent held endowment contract, the life insurance policy is simply not considered for Expected Family Contribution.
Because this is a participating whole life policy it will earn dividends even if money is accessed through a policy loan, meaning one could access the cash and continue to earn money (dividends) on that money. This means the whole life contract could be leveraged for more than just paying for college, and we're not giving up complete compounding growth when we use the money.
I've stated before that cash value life insurance is the product to beat when it comes to college savings plans. It has a multitude of benefits not found as a complete package with any other product. But not all products are created equal. Don't be fooled by products that try to mimic what I'm talking about. The Gerber College Plan falls well short of what we can accomplish with high quality cash value life insurance products.