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5 Mistakes to Avoid When Using Life Insurance in College Planning

Posted by Lori Fogle on Wed, Jul 22, 2020 @ 12:00 PM

Do you have clients or prospects who are planning to help pay for their children's college education? It probably comes as no surprise that the cost of tuition has skyrocketed—but just how much are we talking?

Since 1982, tuition has went up a whopping 500%, which to put in perspective, is twice as much as costs for medical care and three times as much as the overall Consumer Price Index during that same period (Source). 

And the cold truth-- the families who don’t plan ahead may not be able to send their kids to the college of their choice. As a financial professional, you can help put clients in a better position to cover a portion of these costs down the road through their decision to purchase a life insurance policy. 

But here's what you need to know: if you're considering showing clients how to use the cash value in permanent life insurance to supplement costs when college planning-- make sure it’s done correctly. In this post, we’ll cover 5 top mistakes to avoid:


Mistake #1: Starting too late. Not all clients you work with will have planned ahead for how they'll pay for their child's college education. They may be scrambling to figure out how they're going to send their child where they want to go in the fall. If that’s the case, there may still be options for them, other than life insurance.

However, this situation clearly highlights the need to start the conversation early on with your prospects and clients who have a need for a death benefit-- even with younger families that you might not have had life insurance conversations with before.

Discussing the potential to use a permanent life insurance policy to supplement college costs can reinforce their decision to buy and better prepare them for the future.

Not only does starting early give the cash value in a life insurance policy more time to grow, the policyholder gets past the higher expense charges that can drag down the cash value in the initial years of the policy.


Mistake #2: Not using accumulation-focused cash value life insurance. Maybe you’ve heard something about how  you can use life insurance to help your clients supplement the costs of their children’s college education—if so, great. But if you don’t typically use this strategy, you may not be aware that you must use a certain type of life insurance.

In this strategy, you would use cash value life insurance. As defined by Investopedia, cash value life insurance is a form of permanent life insurance that features a cash value savings component. The policyholder can use the cash value for many purposes, such as a source of loans or cash or to pay policy premiums. For this reason, permanent life insurance is more expensive than say, term insurance. But term insurance, does not allow a policyholder to grow cash value.

There are two types of permanent life insurance products that can work in this scenario—whole life insurance and indexed universal life (IUL). The major difference between the two for the purposes of this conversation, is that whole life insurance offers a fixed interest rate and the IUL would provide a client the option to participate in an index, which could offer a more competitive crediting rate. An increased crediting rate can translate to a greater cash value in the long-term.

In a cash value life insurance policy, by the time the child is ready to go to college, the policyholder will have hypothetically grown their cash value and be able to access a portion of it should they need to in order to supplement college costs (or anything else).


Mistake #3: Making withdrawals from the policy instead of taking loans. The cash value of a life insurance policy is not reported as an asset on the Free Application for Federal Student Aid (FAFSA). But the cash value can be accessed to help pay for a portion of college expenses. The purpose of taking loans from a policy's cash value versus a withdrawal to help pay these expenses is that they allow a client to continue funding the policy for other potential expenses down the road-- like purchasing a home or a car, or supplementing their own retirement strategy later in life. Additionally, when a client takes out a loan, if it’s what’s called a “participating loan,” that loaned amount would still continue to earn policy index credits. 

If possible, the policyholder would probably want to pay back the loan on their own timetable, although in most cases, that's not required. As long as the loan was paid back in full before the death of the insured, it would not affect the death benefit amount. If the entire loaned amount and any applicable interest was not paid back, it would be proportionately deducted from the death benefit when it’s paid out.

On the other hand, if a client were to take a withdrawal instead, that amount immediately reduces the death benefit proportionately and they would lose continued cash value growth on the amount withdrawn. Plus, they wouldn't be able to pay it back and restore the death benefit.

The tax treatment on a loan is generally favorable. If the policy is structured properly and wouldn’t violate any modified endowment contract (MEC) guidelines, they would be income-tax free. 


Mistake #4: Not structuring and funding the policy properly. Purchasing any whole life insurance or any IUL policy, does not automatically position a client to be able to use their cash value for college planning. When we help financial professionals with case design, we walk them through what’s required.

Part of that is making sure the cash accumulation can be maximized so that the policyholder can access the money when needed. The goal is to have the policy structured in way that the cash value will grow most efficiently, taking into account the amount of premium and the timeframe the client is working within.

Something else to keep in mind in general around using life insurance to help with college planning-- a client may go into this decision expecting to have the policy for the death benefit and have it as a supplemental way to pay for college expenses, however, when planning this far ahead—the situation could change.

When the time comes, the child may decide they don’t want to go to college—maybe they want to start a business, for example. The good news for parents is that their planning will not be in vain because it’s not stipulated in a life insurance policy that the cash value must only be accessed for the cost of college tuition. That accumulated value could be used for whatever the client might need.

In contrast, a 529 plan--- also used to save for college tuition costs must be used for “qualified education expenses,” otherwise the family must pay a 10% penalty on the plan’s earnings. A properly structured life insurance policy would be more flexible than that.

In the unfortunate event the insured passed away before the child(ren) went to college, a life insurance policy could still be used to carry out this strategy with the income-tax free death benefit.


Mistake #5: Who's Named as Owner, Insured and Beneficiary. Anytime someone purchases life insurance, there must be insurable interest between the owner and the insured. Having insurable interest means the person who owns the policy would suffer a financial loss in the event of the insured’s death.

Occasionally, you may have a grandparent who wants to help their grandchildren pay for college and you have to explain the need for insurable interest. Every case is different but in many scenarios like this, there isn’t insurable interest.

Other times, you might have parents who want to contribute an amount greater than can be accommodated when writing the policy on the child. In those instances, the policy might be written on the parent instead. Then they can use the policy to the fund a portion of the child’s education needs.


The Bottom Line

Designing the case the right way can help your clients reach their goals AND their children’s. If you need help with this, Partners Advantage has years of experience selling and developing IUL. We can help you find a suitable product, make sure it’s properly structured, and do what’s possible to accomplish a client’s college planning objectives in their desired timeframe.

If you have clients or prospects who are looking for death benefit protection and a potential source to supplement college costs, don’t wait—contact us today. This could be a huge weight off their shoulders.

If you want to learn more about this break-away prospecting opportunity using cash value life insurance for college planning, request the OnDemand webinar.

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Tags: IUL (indexed universal life insurance), college planning


This content is for informational and educational purposes only and is not designed, or intended, to be applicable to any person's individual circumstances. It should not be considered as investment advice, nor does it constitute a recommendation that anyone engage in (or refrain from) a particular course of action.

For financial professional use only. Not for use with consumers. This material is intended to provide general information only. It is not intended to render legal, accounting, Social Security or tax advice, and the services of those professionals should be sought. Financial professionals who utilize this material may be able to identify potential retirement income gaps and introduce products, such as fixed annuities, as potential solutions. The testimonial may not be representative  of the experience of other financial professionals and is no guarantee of future success.

Both loans and withdrawals from a permanent life insurance policy may be subject to penalties and fees and, along with any accrued loan interest, will reduce the policy's account value and death benefit. Assuming a policy is not a Modified Endowment Contract (MEC), withdrawals are taxed only to the extent that they exceed the policy owner's cost basis in the policy and usually loans are free from current federal taxation. A policy loan could result in tax consequences if the policy lapses or is surrendered while a loan is outstanding. Distributions from MECs are subject to federal income tax to the extent of the gain in the policy and taxable distributions are subject to a 10% additional tax prior to age 59½, with certain exceptions.