There are a number of ways to pay for a college education and today we want to spend time discussing how you can use whole life insurance to pay for college. While certainly not a default option presented by the mainstream financial media, whole life insurance can work as a wonderful way to pay for college.
But keep in mind that using whole life to foot the bill for higher education comes with a few best practices you should understand. To ensure that you extract the greatest amount of benefit from this strategy, we'll spend some time looking at how people use whole life insurance to pay for college while also giving you some insider knowledge on how to best set up your policy if this is your goal.
Whole Life Insurance has Cash Value
All whole life insurance policies will, at some point, have a cash value. For some this cash value materializes immediately. For other whole life policies, this cash value can take some time to develop. Regardless, if you happen to own a whole life policy that has cash value, you can use it to pay for college. This might be a policy you've owned for decades. Maybe you bought it when you were young and entering the workforce. Or perhaps it's a policy your parents bought for you when you were a child.
Doesn't matter where it came from, or what the original plan was. If the whole life insurance policy has cash value, you are free to use that cash value for whatever purpose you like. Using the cash value in your whole life policy to pay for college takes shape in the following ways: you could simply withdraw cash and use that cash to pay college expenses or you could take policy loans and use the loan proceeds to write tuition checks.
The exact method that will prove best for you depends on a number of circumstances best left as a conversation you have with your insurance or financial advisor. The important take away is that if you have a whole life policy with cash value, you have the option to use it for college expenses.
Specifically Buying Whole Life Insurance to Pay for College
It's great to know that if you happen to own a whole life insurance policy this could be an option as a source for paying college expenses. But what if you are specifically looking to buy whole life insurance with a plan to use it for college expenses? In other words, you don't currently own a whole life policy, but you're considering it and you want to make sure you make the right choice in selecting a whole life policy for this purpose.
That is exactly what I intend to spend the lion share of this blog post talking about. We identified five specific best practices for using whole life insurance as a tool to pay for college. Following these five best practices will put you in the best position to ensure that you not only have a whole life insurance policy with cash value but that you've also strategically positioned yourself to approach affording a college education.
#1 Use Dividend Paying Whole Life Insurance Focused on Cash Value Accumulation
The first, and potentially most important rule is using cash focused dividend-paying whole life insurance policy. You might also see the term “participating,” which is an insurance industry term for dividend-paying. Whole life policies don't come labeled “ready to maximize cash value” so you'll have to do a little leg work to ensure that the whole life insurance policy you are considering is, in fact, one that focuses on cash value accumulation.
A good rule of thumb is to look at how your premium breaks down. A whole life policy focused on cash value accumulation is one that makes heavy use of an elective paid-up additions rider. While the exact amount will vary from one insurance company to another, you at least want to make sure that no less than 50% of your premium goes to the paid-up additions rider.
Loading up the paid-up additions rider ensures that the whole life policy you own will build cash faster than a standard whole life policy. This is crucial for ensuring that you are maximizing your return on premiums paid and building the most amount of cash value possible. Also, I mentioned dividend-paying whole life insurance.
Not all whole life policies pay dividends, and usually, policies that do not pay dividends will lag ones that do. While I cannot say that using a non-dividend-paying whole life policy wouldn't give you the funds needed to pay for college, I can absolutely say that a dividend-paying whole life policy will make it easier as you'll tend to accumulate more cash value with this form of whole life insurance.
Lastly, if you're feeling stuck on just how to find a cash-focused whole life insurance policy, keep in mind that you can reach out to us for help. We are independent life insurance brokers and do business with clients all across the country. You definitely want to be sure that you are making the right purchase working with a competent broker to ensure proper policy design and management.
#2 Insure the Parent not the Child
This one trips a lot of people up, but if you are seeking whole life insurance to pay for college I strongly recommend against insuring your child for this purpose. I know you probably thought that because you are doing this for the benefit of paying for a child's education it probably made a lot of sense for this to be a whole life policy insuring the child.
But this approach has a lot of pitfalls and drawbacks. Most importantly, if the child is the insured and a parent (especially a primary breadwinning parent) dies, then the child has a whole life policy with a premium due. If on the other hand, the whole life policy insures the parent and that parent dies, the death benefit solves the college funding problem.
Additionally, whole life policies issued on children often cannot accommodate the premium size necessary to accumulate the cash value needed to ultimately pay for college. Given their very young age, a seemingly small amount of premium can create a large amount of death benefit that goes way beyond the levels of reasonableness for death benefit on a child.
Life insurance companies are very hesitant to issue high death benefit amounts on a child and this restriction/limitation causes a serious impediment to accumulate lots of cash value in the whole life policy. Remember, the cash value is the key component of using whole life insurance to pay for college.
#3 A Policy that Offers Multiple Payment Options
Consider the following scenario. You just welcomed your child into the world. There's a flurry of excitement, but now you only have roughly 18 years before he/she heads to college. Once college begins, you might want a break from putting cash away, so it makes sense that you might prefer a whole life policy that requires no future premium payments once your child enters college. This is absolutely doable.
Whole life insurance possesses the versatility to accommodate a number of different payment option periods, and a policy designed with the idea that you stop paying premiums once college begins is no problem at all. Know, however, that this is entirely optional. If you'd prefer to continue making premium payments during and after college, a whole life policy can certainly accommodate that plan as well.
What's more, you don't even really need to make a decision on when you'll ultimately stop making premium payments when you first purchase the policy. The decision to stop paying premiums can come along whenever you want.
#4 Not Best Option If College Start Date Is Soon
If you are only a year or two away from making your first college tuition payment and you don't yet own a whole life policy, it's unlikely buying one now will be a good idea if the plan is to use it to pay for college.
Whole life insurance needs a few years to build cash value, so those who are really short on time won't have enough time to build any real benefit from the whole life policy. Ideally, I would recommend that any concerted plan to use whole life insurance to pay for college requires that you make your whole life purchase around 10 years prior to the first tuition payment.
#5 The Policy Should Not be a Modified Endowment Contract
Modified Endowment Contracts (MEC) remove some of the best tax features regular life insurance policies enjoy. For this reason, I'd strongly recommend against using a MEC to pay for college. It's not impossible to use a Modified Endowment Contract to pay for college, but you'll very likely end up paying a lot of income taxes on the distributions you take to pay for college. This causes a few problems.
- The additional income you must report might negatively affect your qualification for financial aid in subsequent years.
- The additional taxes due on the distributions might require larger distributions from the MEC, which means you might not be able to accumulate enough money to pay for college within the policy.
- If you are under 59.5 you'll be subject to a 10% excise tax in addition to ordinary income tax when takin a distribution from a MEC.
A Focus Beyond Just Paying for College
Whole life insurance often comes up as an option to pay for college because it:
- Has solid and reliable returns that will allow you to accumulate the cash you need to cover college expenses.
- Allows you to accumulate large sums of money that most colleges will never consider when determining your eligibility for financial aid.
- Permits you to withdraw large sums of money from the policy to pay for college with zero tax consequences.
However, whole life insurance can pay for college and provides funds for so much more. When using whole life in this capacity, you can unlock some serious benefits afforded by life insurance and achieve an effective rate of return that is the envy of a lot of other financial savings products.
This is just one of the many benefits you get as part of owning the right whole life insurance policy. We explain more in our book Predictable Profits.