Life insurance and college: seemingly unrelated topics, right? Not necessarily. Did you know that certain types of life insurance can be used to save money for your child’s college tuition? Here we’ll explore how that’s possible and if it’s recommended.
Can Life Insurance Pay for College?
It’s no secret that college costs a fortune these days, and many young parents start worrying about how they’ll pay for this large expense when their children are still young. And that’s smart — planning ahead is a great way to ensure that you’ll have enough savings to pay for college.
Traditionally, the 529 plan, as explained by Investopedia, is the method of choice for college savings. But there’s another option as well: permanent life insurance.
Permanent life insurance includes a death benefit in the event that you die and also a savings component. If you buy it as a new parent, you can accumulate a fair amount of cash value, which you can withdraw during your lifetime or borrow against. Either way, that cash value can help you pay for your child’s college education.
Is Life Insurance a Good Way to Save for College?
Now that we know it’s possible to save for college using permanent life insurance, the question is, is it a good idea? There are pros and cons of using life insurance to save for college, especially compared to a 529 plan.
With a 529 plan, the savings counts as an asset when your child applies for financial aid for college. A permanent life insurance policy does not. Additionally, if your child decides not to go to college, the earnings in your 529 account will be subject to income tax rates and sometimes a 10% tax penalty if you withdraw them. This isn’t the case with life insurance.
However, a permanent life insurance policy can come with higher fees than a 529 plan, which makes it more expensive to maintain. In fact, it can take 10 years or more for the cash value of your policy to surpass what you’ve paid in premiums. Additionally, universal life policies have clearly specified fees that can be upwards of a couple percentage points, and any additional monies paid into a whole life policy will be assessed with a load fee as well.
Therefore, using life insurance as a way to pay for college is only worthwhile if you buy a policy when your child is a baby or toddler. You must give your cash value enough time to accumulate in order to meet the goal of paying for college.
How Does Permanent Life Insurance Work?
Permanent life insurance is an umbrella category that includes different types of policies, including whole and universal. Whole life insurance is often chosen to pay for college. Most permanent policies accumulate a cash value and last the policyholder’s entire lifetime.
Term life insurance, on the other hand, is a completely different type of policy. It only lasts for a certain number of years, called a term, and doesn’t come with a cash value. Due to the lack of cash value, it shouldn’t be considered if saving for college is your main goal. (However, it’s a good type of life insurance for college students themselves — discussed at length further on.)
The way permanent life insurance works is that a portion of your monthly premium goes toward paying for death benefit coverage and another portion gets deposited into a separate cash value account. The money in the account grows tax-deferred and isn’t considered an asset when applying for financial aid for college.
Accessing the Cash Value of a Permanent Policy
There are several ways to access the cash value of your policy to pay for your child’s college education. You can:
- Take a loan against the value of your policy, which you must pay back in full. (If you die before the loan is paid back, the outstanding debt will be taken off the policy’s death benefit.)
- Withdraw the cash value, so you don’t need to pay back the loan but you know from the get-go that the death benefit will be reduced.
- Surrender the policy and receive the entire cash value. A universal life policy will also have a surrender fee charged by insurers. This is the least ideal option, since your entire policy will be liquidated.
Yes, it’s possible to use life insurance to pay for your child’s college education. In addition to the death benefit that’s standard to all life insurance policies, the cash value of a permanent policy can be used as a sort of child life insurance college fund. However, there are pros and cons when comparing permanent life insurance to other investment vehicles, namely the 529 plan.
When deciding which investment vehicle to choose, the main thing to keep in mind is that in order for a permanent policy to be a worthwhile savings plan for college, you need to buy it when your child is a baby or toddler.
Still have questions? We have answers! Read on to find out more about using life insurance to pay for college.
Can I use life insurance to pay for college?
When the question is being asked by a parent on behalf of their children (i.e., the parent wants to save money to pay for their child’s college tuition), the answer is yes. The cash value of a permanent policy can indeed be used to pay for a child’s college tuition.
However, when the question is being asked by the potential students themselves, the answer is no. In other words, a potential college student may have heard that you can use life insurance to pay for college, and is now considering a policy for that purpose. This won’t work. The policy usually needs to be in place for at least 15 years in order for the cash value accumulation to be worthwhile.
If a student wants to get life insurance while in college, they certainly can. In fact, the younger you purchase life insurance, the lower your rates will be. But the life insurance policy won’t be able to pay for college at that point in time.
What type of life insurance is best for students?
Term life insurance is usually the best life insurance for college students, since permanent policies are significantly more expensive. A term policy is an ideal choice for a college student who has student loans. A life insurance policy can ensure that their debt doesn’t get passed to their parents or loved ones if something happens to them. In this case, the length of the term needs to be based on the number of years it will take to pay back the student loans.
If at some point during the term, the student gets married and/or has kids, they may want to convert their policy to a permanent one or buy an additional term policy to cover their new expense.
For parents buying life insurance as a way to save for their children’s college tuition, whole life insurance is a popular choice for college savings, although some prefer universal. Either way, it’s important for parents to choose a type of permanent life insurance that includes a cash value in order for the policy to be used for college savings.
Does a college student need life insurance?
No one needs life insurance, though it is highly recommended for people who fit certain criteria. Those with significant debt, who are married, have children, or have an independent business venture are strongly recommended to get life insurance. In the case of securing an SBA loan, most lenders will require life insurance, as explained by smartbiz. But this isn’t the case with student loans.
So while it’s a good idea for a college student to get life insurance, for the reasons explained above and in this Forbes article, it’s not mandatory.
How do college students get insurance?
College students get insurance the same way everyone else does. If their parents already have insurance, they can choose to go through the same insurer. If they want to try and get a deal, they can visit Sproutt and get a roundup of the best quotes available.
Does life insurance have to pay off student loans?
Whether you buy a life insurance policy as a parent or a college student with the purpose of paying off student loans, no one will force you to use life insurance for that purpose.
For example, if a parent bought a whole life insurance policy when his child was born for the purpose of paying for college, but then their child got a full scholarship, it’s no problem to use the cash value in that policy for something else. (Bear in mind that if you have a 529 plan and the child doesn’t end up going to college, parents can be penalized with fees.)
If a student took out term life insurance to cover their student loans and then managed to pay them back quicker than expected, the death benefit can be used for other purposes by the beneficiaries.
Can international students get life insurance?
Yes, international students can get life insurance, but their choices are usually limited. Additionally, they must be able to provide legitimate documents to prove their status in the United States, i.e. a green card or a visa. While choices might be limited, international students should consider life insurance for the same reason local students should: to protect their families from student debt.
You can contact Sproutt insurance advisors to find out what your life insurance options are as an international student.