Cash-Value Life Insurance: A Costly College Savings Plan
If you’re a parent, you can readily understand the importance of a college education to your child’s future. Unfortunately, even as the growth of our knowledge-based economy makes advanced education a necessary prerequisite for success, the challenges of saving for that eventual diploma have never been greater.
With state governments across the country struggling to balance their budgets, the burden of higher education has increasingly been borne on the backs of parents like you. According to the National Center of Education Statistics, the average one-year cost of tuition, room, and board at a public university is now $13,600. Even after adjusting for inflation, the costs of college have grown by more than 40% in the past decade alone.
At the same time as tuition costs have skyrocketed, many investors have recoiled from a stock market that’s been ravaged by both an internet and real estate bubble during the so-called “Lost Decade.” Instead, investors have fled to the safety of U.S. Treasuries and other low-risk investments, which has helped to drive interest rates down to historic lows, making it nearly impossible to earn a reasonable rate of return without the assumption of significant volatility.
With traditional strategies seemingly incapable of providing the risk-adjusted returns necessary to pay for an increasingly expensive college education, other ideas have stepped into the breach. One strategy that’s gained considerable popularity is using cash-value life insurance policies as an investment vehicle for college savings.
Although not originally intended as such, cash-value life insurance policies seem to have many positive attributes that would make them a serious possibility for anyone saving for college. Unlike term-life insurance, cash-value policies provide families with financial protection against death while simultaneously accruing cash value, which can be accessed to pay for things like tuition. This money grows tax-free, can often be withdrawn without any tax liability, and is not counted as an asset for the purposes of financial aid. When combined with a guaranteed minimum rate of return that some policies offer, cash-value life insurance can have a particular allure for those seeking to combine safety and return.
Unfortunately, first impressions can often be deceiving. In the investment world, perhaps the only thing more expensive than safety is complexity. There are few investment products more complex than cash-value life insurance, which comes in a variety of guises like whole life, variable life, universal life, and even variable universal life policies. The dizzying array of options can exasperate even the experts.
Regardless of the specific version chosen, however, all cash-value life insurance policies are riddled with high costs that make them unsuitable for most families. First, there are the commissions that are earned by the agent that sells you the policy. In addition, there are fees associated with the investment account, which are typically far greater than those charged in other savings vehicles such as 401(k)s, IRAs, and 529 college savings plans. Finally, there are the surrender charges if you decide to cancel the insurance prematurely.
As a general rule of thumb, policyholders will only be able to overcome the high fees associated with cash-value life insurance if the policies are held for at least 20 years. However, if you are planning to use a cash-value life insurance policy solely for the purpose of paying for college expenses, you won’t have 20 years before you start to access the account. Even if you have every intention of maintaining the policy for many years after your children head off to college, the combination of tuition costs and other expenses may become too onerous, requiring you to terminate the account and surrender much of your investment. According to a study by the Society of Actuaries, nearly 40% of cash-value life insurance policyholders liquidate their investment within 10 years because they’re unable or unwilling to continue making the premium payments.
When it comes to your personal finances, it’s generally better to avoid conflating your investments and your insurance. Instead, consider a term-life insurance policy to protect your family, and use the considerable savings from the lower-cost policy to make contributions to a 529 college savings plan or a Coverdell ESA. If you are worried about the risks associated with the stock market, you can invest this money in a low-risk bond or money market fund, which provide downside protection at a far lower cost than a cash-value life insurance policy.
Saving for college is hard enough without needlessly surrendering thousands of dollars in fees to insurance companies. That money could be used to actually pay for the education of your children.
