529 College Savings Plan vs. Life Insurance
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UPDATED: Nov 3, 2021
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- 529 College Savings Plans can significantly out perform a life insurance policy in some situations
- Life Insurance Policies give more guarantees
- 529 Plans can be restrictive in their uses
When it comes to saving for your child’s college education, where you put the money could impact his or her ability to adequately finance all four years of college.
Using a 529 college savings plan has been preferred by many people because of the tax benefits offered by some states and the tax-free withdrawals.
However, the opinion about whether 529 plans are the best way to go has changed in recent years.
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What is a 529 College Saving Plan?
A 529 College Savings Plan is where you can contribute up to $14,000 per year, above this you may have gift taxes towards one child’s college education.
It could be a child of yours, a close friend or even for yourself. The person setting up the plan is the one who must manage the investments in the plan.
Many people invest in mutual funds or stocks and bonds. These funds are susceptible to market fluctuations.
– Pros of Using a 529 College Saving Plan for Education
529 College Savings plans accumulate tax deferred as they grow. No income taxes need to be paid on the gains in the account.
If the beneficiary of the plan goes to an appropriate university or college, they can take withdrawals from the plan without ever paying taxes on the gains. All the money must be used for allowed expenses like tuition, books, etc.
If the beneficiary decides not to go to college, the account holder can change the beneficiary to another family member.
Most colleges and universities in the United States are acceptable by the regulations. If the money is invested successfully, it can far outperform most any other type of college saving plan.
If the stock market is up for the most part, and the handler makes the right investments, they can grow to quite a large sum by the time college tuition’s come around.
– Cons of Using a 529 College Saving Plan for Education
What for some could be a major benefit, could be a major disadvantage for others. Since the account holder must make the investment decisions, there is the possibility of losing money as well.
There is no guarantee that you will get the best returns. If there is a market correction like the one that happened in 2007-2008, right at the time you need to start paying tuition, it could be a difficult time for all.
So, there are no guarantees that the money will be there when you need it. Another con for 529 plans is that if the money is used on things aside from tuition, books, room and board it may be considered a non-educational expense.
If that happens you will have to pay taxes on the money used, as well as a 10 percent penalty.
Many parents have found that there are college expenses their kids incur that fall in this area considered non-educational.
What about a car to get around in or money for gasoline? Many things fall in this non-educational area. Parents have found that the 526 plans can be a bit too restrictive for their needs.
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Life Insurance vs. 529 Plan
What some people are forgetting about a 529 plan is that it is not self-completing. What happens if the primary income-earner in the family dies before the 529 is completely funded?
Most people don’t think about this issue. They think they are invincible.
If you are the unlucky person who dies too soon, what will your kids do? This is one aspect of a life insurance policy that has no substitution.
– Pros for Using a Life Insurance Policy for an Educational Fund
A life insurance policy offers much more flexibility than a 529 plan. You can over-fund your premiums early with life insurance, creating a cash value that grows tax-deferred.
Later on, the policyholder can borrow from the cash value, tax-free, as long as the policy stays in effect to pay for tuition or anything else for that matter.
If you child gets a scholarship, then the money in the life insurance policy can be used for something else. There are no restrictions.
Another pro for using life insurance to fund a college education is that it does not count as an asset when applying for financial aid.
It is also safer than investing in the stock market. Most whole life insurance policies have a guaranteed cash value growth that protects you from downside slides in the financial markets.
Some may pay 4 -5 percent returns after an initial period. There is just no downside possible. For many people having a guaranteed outcome is very beneficial. You know that you will have a certain amount by a specific date.
One of the most overlooked aspects of using a whole life insurance policy to fund a college education is that is self-completing.
This means that if you or the income earner in your family dies before the cash value has built up enough to fund the education, the life insurance death benefit will complete the funding.
If you have a 529 plan and the income-earner dies too soon, you will have a problem.
While you are paying your child’s college education, by borrowing from the cash value of the policy, if the policy remains in force, it continues to gain cash value.
After your child has graduated and is on their own, you can use the same life insurance policy for retirement income down the road.
– Cons of Using a Life Insurance Policy for Educational Funding
The fees attached to a life insurance policy can be high. You have to cover the cost of the death benefit and other expenses. It may take several years before you start seeing an increase in the value.
Guaranteed cash values will put a cap on your returns. You will not experience large gains if the stock market soars. In those states that give a tax deduction, you will not get this, with a life insurance policy.
In conclusion, before starting a funding method for your child, consider the pros and cons of both the 529 college savings plan to a whole life insurance policy.
There are benefits and pitfalls to each. If you want guarantees and security, you may want to lean towards life insurance. If you are a market expert and have a term insurance policy the 529 may be your best option.
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