If you’ve been following my blog the past several weeks, you’ve seen how different college savings plans − including the 529 Plan, Coverdell ESA and UTMA accounts − can help parents get on track for saving for their children’s education and save taxes in the process. My last post will discuss a lesser-known and often under-utilized college savings tool; life insurance.
As a financial planner, I often see a reaction of surprise and reservation when I bring up using life insurance as a cash-accumulation vehicle. But if we remove prejudice from the evaluation, I find it to be an extremely safe and powerful investment strategy.
Individuals take out an insurance policy for a specified benefit amount, and pay premiums to the plan. The excess cash value may increase based on a variety of investment options that can be chosen. At certain points during the life of the policy you can access the cash value of the plan (the surrender value) and use it for whatever you wish, including college education.
The beauty of using life insurance in financial planning lies in our tax code. Section 7702 of the Internal Revenue Code dictates how cash values of life insurance are taxed. It is one of the only cash value products that allow FIFO (first in first out), and can be a powerful tool against paying taxes.
With regular investments and savings plans, when you withdraw funds you must start with any earnings you have had, and thus pay capital gains taxes associated with those earnings. But with an insurance policy, you can withdraw the premiums you’ve paid into the policy first (your cost basis) and pay no taxes at all. If you need more money than the cost basis, you may be able to take a loan against the remaining funds instead of withdrawing them. The loan is often tax free, and you may be able to avoid paying taxes all together.
There are no income limits, maximum contributions or age requirements at which you are restricted from taking the funds, or forced to. Policy holders must pass a physical, however, so overall health is a factor.
While family protection is a popular reason why people buy life insurance, providing for kids’ education is also a great one. The right policy can do both, for if you die before your children attend college, the death benefit can be received by your spouse or kids tax free, and used to pay the upcoming educational expenses.
As there lots of insurance products on the market with various surrender conditions, I recommend working with a qualified professional who can help you choose a policy with low fees, limited or no surrender charges, and small or non-existent premium loads.
You may find that you will need to use a few of the savings plans we have detailed over the past five weeks. Good luck!
Joe Wirbick is the President of the Lancaster, PA financial services firm Sequinox. Joe specializes in retirement planning and distribution. This allows him to concentrate on developing strategies that help address the unique issues that confront retirees and those approaching retirement.
Tax advice provided for informational purposes only. Tax returns should be completed in conjunction with a qualified tax professional. Sequinox Financial and JWC/JRAG do not offer tax advice and are not affiliated. Mr. Wirbick is an Investment Advisor Representative offering advisory services through Jonathan Roberts Advisory Group and securities through J.W. Cole Financial, Inc. Member FINRA/SIPC. The opinions expressed are those of Mr. Wirbick and based on information believed to be reliable but not guaranteed and subject to change and do not necessarily reflect the position of JWC/JRAG.