Using Your Life Insurance to Help Pay for a Child's College
A financial planning expert on how it can ease the tuition burden
Now that the fall semester at college has begun, many parents have the high cost of higher education tuition on their minds. Rising college bills, plus the cost of dorms, travel and books really adds up. If you have a child in high school or college, you may want to know about an unconventional and often underutilized way to help pay the tuition: your permanent life (whole life or universal life) insurance policy.
While many people understand that a life insurance policy pays a death benefit to beneficiaries, in the 2018 Life Insurance Needs Survey by Allianz Life Insurance Company of North America , more 51 percent of Americans surveyed were unsure or didn’t believe that cash value from permanent life insurance can be used to help fund college education. And 66 percent were unsure or didn’t believe benefits paid from life insurance are generally income tax free.
How Cash Value Can Help Pay for College
While the primary reason my wife and I bought permanent life insurance policies was to protect our daughters in the event she or I died early, we also knew they could provide the opportunity to accumulate cash value inside the policies. We could then potentially borrow against the cash value through policy loans to supplement our college funding strategy should we need it —assuming the policy had accumulated sufficient cash value to support loans.
(A word to the wise: Policy loans and withdrawals will reduce the available cash value and death benefit and may cause the policy to lapse or affect guarantees against lapse. Additional premium payments may be required to keep the policy in force. And withdrawals in excess of premiums paid will be subject to ordinary income tax.)
A percentage of each dollar my wife and I paid into our permanent life policies goes to the cost of insurance and expenses that help pay the death benefit, with the rest going toward a cash value portion that has grown tax-deferred over the years. (Of course, this is experience — there is no guarantee that a policy will earn sufficient interest to support a loan strategy.)
A portion of the money paid into the policies can help fund college expenses by taking out a loan against the cash value balance and using the money income-tax free, which must be paid pack with interest.
A Few Caveats
One thing to keep in mind is that the loan — plus any interest paid — cannot exceed the total cash value of the account. If this happens, you’ll need to add in more money to the policy or it could lapse, and you’ll end up paying taxes on the difference. If you’re going to use policy loans, be sure to carefully manage your policy values to help prevent a lapse and adverse tax consequences.
Additionally, if you die before repaying the loan, the death benefit is reduced, which can have a negative financial impact on your family during a difficult time. That prospect is less of a concern for my wife and me because our daughters are close to being fully launched. so a reduced death benefit feels OK to us.
Another benefit of using a permanent life insurance policy to help pay for college: the cash value doesn’t currently factor into college financial aid calculations. That means your child will be able to get the most out of his or her aid while you still have the life insurance policy as an potential additional resource, if needed.
Consulting with a financial professional and your tax adviser can help you determine if a permanent life policy may be suitable for your needs and circumstances.
After recently dropping our freshman daughter off at college, my wife and I are glad we have a plan to pay tuition for all four years, with our life insurance policies available — should we need them — to help.