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Insurance products provide protection, flexibility for grandchildren's college fund

by Joseph Arroyo | Contributor
September 1, 2020

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College is both very expensive and very necessary to people entering the workforce in today’s job market. It is so expensive, in fact, that many young people can’t afford to attend, or can’t afford the payments on the student loan debt they must take on to get a college education. As a grandparent, you may wonder how you can help out, but setting up a college fund for your grandchildren requires a solid plan. We’ll review some of the common college funding methods and dive into details on how you can use insurance products to meet this unique need.

Consider your options for helping your grandkids with college

It’s only natural to want to help with such a large but important expense as college education. Unfortunately, to be meaningful, the help must be significant. The average cost of a four-year degree is more than $80,000 – and that’s just for an in-state public university. If you have multiple grandchildren, you can do the math, but it’s going to add up to a lot of expense.

To help pay for college for grandchildren, you have three main options:

  • Save in after-tax investment accounts
  • Use state 529 college savings plans
  • Use guaranteed insurance products

There are other options, like Coverdale Savings Plans (education IRAs), but with contribution limits as low as $2,000 per year, these are not likely to make a large dent in the cost of college for your grandchildren. Let’s review some of the pros and cons of these three main college funding tools.

After-tax accounts

These accounts can run the gamut from bank accounts to mutual funds. Using this strategy you would deposit money on an after-tax basis. There are no contribution limits to this type of account.

You have an almost unlimited number of investment choices with this approach. This will give you the opportunity to earn large investment gains, but will also expose you to market losses in down years. You will also be liable for taxes on dividends, interest and capital gains.

Table showing effects of tax on investment accounts

529 college savings plans

As a college funding vehicle, 529 plans have become very popular. With a 529 plan, you can make unlimited, or nearly unlimited, contributions. You also have access to a wide variety of investment options, but those that are available to you are chosen by the plan’s investment manager.

A 529 plan offers tax-deferred growth. You don’t pay taxes on any gains, interest or dividends until you begin making withdrawals to pay for college. On the downside, the funds must be used for education; if your grandchild doesn’t attend a qualifying institution or gets a full-ride scholarship, there may be a 10% excise tax to withdraw money. Also, 529 plans are subject to market loss and can lose money.

Table showing pros and cons of 529 plans

Insurance products

The third option is to use insurance products to fund your grandchildren’s college educations. When you go with this method, you have several insurance products available:

  • Life insurance
  • Annuities
  • Endowment contracts

Insurance products have several advantages over the other two strategies:

  • They often come with a guaranteed interest rate, protection from market loss or a combination.
  • The money can be used for any purpose – if your grandchildren don’t need it for college, it can be withdrawn without paying an excise tax.
  • Insurance products also offer tax-deferred growth.
  • Life insurance can pay a death benefit, which can enable you to leave more money for your heirs than you would have been able to accumulate in savings.

There are potential negatives to using insurance products, including:

  • Potential for high fees.
  • Comparatively few investment choices.
  • Lower potential for large investment gains.

You can make up for these negatives in several ways, however. First of all, fees are often incurred if you withdraw money from an annuity or surrender an insurance policy during the first 10 years. If you hold these products for more than 10 years, you can avoid surrender charges.

Secondly, you can use indexing options with some life insurance policies and annuities to gain access to market-based investment returns. As mentioned above, these indexed policies will also protect you from market losses, so you can have your cake and eat it, too.

You want to make sure that you use the appropriate types of insurance. You’ll want to avoid term life insurance. Instead consider:

  • Whole life insurance
  • Indexed Universal life insurance (IUL)
  • Fixed and indexed annuities
  • Endowment contracts designed to help pay for college

Annuities, indexed universal life insurance and endowment contracts are great tools to use if you want to reposition large amounts of your portfolio into your college fund. You can make large deposits (premium payments) to these contracts, and also make ongoing premium payments to continue accruing interest for years to come.

You may see negative press about endowment contracts for college savings, but make no mistake, these are the only options available to you that can guarantee to pay a known lump sum amount at any time in the future. If you value certainty, and want the peace of mind that comes with knowing that a certain amount of money will be available by a certain date, consider an endowment contract.

Establish a trust to guide the use of college savings

To give yourself both maximum flexibility and control over your college savings, you should consider using a trust. You would make the trust the beneficiary of any of the insurance policies, annuities or endowments you fund.

You can write very specific instructions into the trust to dictate how and when the funds are to be used. For instance, you can specify that money can only be distributed during college years and for college expenses.

You can also specify conditions that must be met in order for your grandkids to receive money, like a minimum GPA or minimum number of classes taken. You can also allow the trustee of your trust the flexibility to still make payments to a grandchild who maybe doesn’t need the college money because they got a scholarship – maybe you instruct the trustee to give them a house down payment money instead.

College funding and estate planning

Make sure that your retirement and estate plan professionals know of your desire to help pay for your grandchildren’s college. Definitely consult with them before you purchase any new life insurance or annuity products. Also, make sure you’re committed to this plan for the long haul so that you aren’t exposed to surrender charges.

Alliance America can help

Alliance America is an insurance and financial services company. Our financial professionals can assist you in maximizing your retirement resources and achieving your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.

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