One of the mantras my children hear a lot is, ??????don????????t complain unless you have a better solution.?????? A few weeks ago I complained about the drawbacks of 529????????s: the fees, the unpredictability, the increasing taxes you pay on this type of ??????tax-deferred?????? account, the lack of any guarantee on principal or growth, and the fact that the account is useless if the government administrator decides your child????????s choice for education does not qualify.
But, what is the solution then? Thankfully, there is a good one – an account YOU control; one that offers guarantees, liquidity, and flexibility; an account you can use to remodel the kitchen, take a family vacation or buy a new car while it grows, and still have it available when you need to fund a college education. That solution is a specially designed whole life policy. Now, before you toss this aside and assume you know it all, take a look at a simple case study.
Just a quickly reminder about the basics of this type of policy before we go on: there are three players in this scenario; here????????s what they do:
THE OWNER (parent/grandparent)
* controls the policy, including all the cash value
* designates beneficiary
THE INSURED (child/grandchild)
* can contribute to the policy
* has no access to cash value
MUTUAL LIFE INSURANCE COMPANY
* determines insurability
* provides administration
Jack and Nicole bought a policy on their daughter, Siri, when she was 8 years old, which they now plan to use to finance her college education. The table (above, right) illustrates the whole life policy when Siri is between ages 18 and 22.
We will estimate Siri????????s total college bill for a 4-year program to be $60,000: $10,000 per year for tuition and books, and $5,000 for living expenses. (Obviously, this amount varies depending on the school Siri chooses to attend; the figures used are only an example.) Siri is able to get a very favorable interest-subsidized student loan for $40,000 to pay for tuition and books, but she still needs money for living expenses. Siri????????s parents are going to borrow $5,000 per year against the policy over 4 years to cover those expenses.
They are going to let these annual loans and interest accumulate. In fact, they aren????????t going to make a single payment. (This is one of the benefits of using a whole life policy: you are in control of the repayment terms of any loan you make from your policy.)
So with the 8% interest on the policy loan, by the end of the Siri????????s 4 years in college, the cumulative loan amount is $24,333. They want to repay the $40,000 student loan Siri took advantage of by borrowing against the policy once Siri graduates, just as the student loan repayment schedule starts. This way they are optimizing both the student loan terms and also the availability of credit with the whole life policy. So Jack and Nicole take a $40,000 loan against the policy, making the total accumulative loan $69,480.
Let????????s look at the table to understand what happened inside the policy during these 4 years. Jack and Nicole paid a total of $66,715 in premiums. Even with the cumulative loan of $69,480 ($60,000 plus interest), the net cash value of the policy has grown by $42,039. After paying the policy premiums and taking out the loans Jack and Nicole are left with $39,274 more cash than they have paid into the policy. In addition, from the age 18 through age 22, the death benefit has grown by $460,625.
As they agreed, Siri didn????????t have to make payments while she was in school, but once she graduates, she will pay for her college experience. Jack and Nicole arrange a loan repayment schedule that allows Siri 10 years, at $12,000 per year to pay back the loan.
age net premium annual loan net cash net death
premium outlay loan payment value benefit
18 $13,343 $145,143 $5,400 $0 $171,487 $2,323,156
19 $13,343 $153,486 $5,832 $0 $189,720 $2,446,531
20 $13,343 $161,829 $6,299 $0 $208,993 $2,570,634
21 $13,343 $170,172 $6,802 $0 $229,450 $2,695,357
22 $13,343 $143,515 $45,147 $0 $213,526 $2,783,781
This may seem like a high payment for someone who has just graduated, but remember, Siri will eventually get all her college loan payments back, and then some, via the net cash value in the policy which she can turn around and use again in the future to buy a home, or pay for a wedding. And the parents are free to make other arrangements if they desire.
In the interest of space, I????????ll forgo the explanation of the further benefits for Siri and her parents as they continue to use the policy year after year (There are a lot of them!). Financing her education is only the beginning. Hopefully this illustration proves sufficiently the absolute superiority of this type of account over 529????????s in financing a college education. In short, there is no comparison if you know what you are doing.