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Planning for a Child’s Education with FinFit Life

College costs are considered a major expense for most individuals, and it is important to take a proactive approach when saving for a child’s education. While there are a variety of funding options and savings techniques available in the marketplace, using life insurance for college funding can give parents enhanced flexibility. Life insurance can be used as a savings vehicle, where cash value is built up within a policy and later withdrawn to pay for college expenses. Alternatively, the policy’s death benefit could provide the funds needed to pay for expenses in the event a parent’s death.

Withdrawals from insurance policies are not mandatory and may occur at any time or not all. This is unlike distributions from a 529 plan, where the distributions have to be used for qualified higher education expenses, otherwise a 10% penalty and tax will be assessed on the gain.

Understanding the Options

  1. 529 Plans: These plans are very popular. Individuals select these accounts because they offer a tax-advantaged way to save for college. 529 plans grow tax-deferred and funds may be distributed tax-free if utilized for qualifying higher education expenses. However, many individuals have concerns over flexibility as it pertains to these types of accounts. For instance, if a 529 plan is not used for college education, a 10% penalty plus ordinary income taxes will be assessed on the gain within the plan. While there are some ways to transfer the beneficiary designations to a family member (e.g., the plan can be transferred from one sibling to another in most plans), what if that option is not available/applicable for your client's family? Furthermore, most 529 plans have restrictions to how much money can be invested, and while these limits are high, there is a ceiling to be mindful of.

  2. UTMA/UGMA Accounts: For practical purposes, these accounts are for the exclusive benefit of a minor, but are managed by a custodian until a child reaches the age of majority (anywhere between 18–21 years, depending on the state). These types of accounts do not necessarily have to be used for higher education, and are automatically transferred to the minor as soon as he or she reaches age of majority. If a child does not go to college, he or she is free to spend the account however he or she wishes, which may frustrate the intent of the individual who initially funded the account.

  3. Coverdell Education Savings Plan: These accounts have income limitations as well as contribution limits ($2,000 in 2017). These accounts grow tax-deferred and the money is tax-free if used for qualifying education expenses. These accounts can also be used for education expenses prior to college, such as tuition for a private high school.

  4. Mutual Funds and Retirement Accounts: Mutual funds can offer the most flexibility because money can be invested and withdrawn without any additional tax penalty. Money in the account belongs to the owner, and as such, the owner can control who receives distributions, if any. Mutual funds have taxes associated with them, such as capital gains and dividends. Although retirement accounts, including 401(k)s and IRAs are typically reserved for retirement spending, some people will earmark a portion of money in these accounts to fund a college education. While money in a retirement account grows tax-deferred, most individuals should be aware that access to this money prior to age 59 1⁄2 may result in a 10% penalty and taxes will be associated with the withdrawal. (IRAs may be accessed for higher qualified expenses, without the 10% penalty. Please consult your tax advisor for more information.)

  5. Permanent Life Insurance: Life insurance provides a death benefit should something happen to your client. Part of the tax-free death benefit can be used to fund a child’s education. In addition, the cash value build up in a life insurance policy can be accessed for college education purposes. The cash value is tax-deferred and comes out tax-free if the contract is structured properly. If a child does not need the funds for college expenses, the cash value can continue to build for use towards future goals, such as retirement.

Financial Aid Federal Student Aid, a part of the U.S. Department of Education, considers the parents’ income and assets as well as assets and income in the child’s name to determine how much, if any, federal financial aid the student is eligible for. Other factors, such as whether or not the child has other siblings currently enrolled in college, will also factor into the family’s ability to contribute. It should be noted that most financial aid packages generated for students consist of loans, while grants and scholarships are often secondary. Some institutions may have additional requirements for determining aid, although most require federal forms. Some assets are not considered when determining aid, such as 401(k)s and IRAs. (Note, however, if money is taken out from an IRA, this will count as income for the following year, as financial aid is determined on an annual basis.) Life insurance cash value is not currently factored on the federal level, but certain institutions may require it at their level. (If a policy is surrendered, though, it would count towards the family contribution.) Generally, UTMA/UGMA accounts are heavily weighed in determining aid and tend to have the highest impact on whether or not aid is granted. Considerations

  • Life insurance has costs and fees associated with it. Policies should not be classified as a Modified Endowment Contract (MEC).

  • Policies classified as MECs may be subject to tax when a loan or withdrawal is made. A federal tax penalty of 10% may also apply if the loan or withdrawal is taken prior to age 59 1⁄2.

  • Life insurance eligibility will be based on financial and medical underwriting.

  • Loans and withdrawals will reduce the death benefit, cash surrender value, and may cause the policy to lapse. Lapse or surrender of a policy with a loan may cause the recognition of taxable income.

  • Cash value available for loans and withdrawals may be more or less than originally invested.

  • Life insurance death benefit proceeds are generally excludable from the beneficiary’s gross income for income tax purposes. There are few exceptions, such as when a life insurance policy has been transferred for valuable consideration.


  • Life insurance can increase the amount left to heirs.

  • Life insurance provides an income tax-free death benefit.

  • The life insurance policy cash value grows tax-deferred.

  • Life insurance, depending on the state, can offer creditor protection.

  • Withdrawals from insurance policies are not mandatory and may occur at any time or not at all, unlike distributions from a 529 plan, which have to be used for qualified higher education expenses, otherwise a 10% penalty and tax will be assessed on the gain.

Why Use Life Insurance? Life insurance can offer your clients peace of mind in knowing that their children will be protected should something happen to them. In addition, money saved into life insurance has little to no limitations. If their children decide to go to school, the money is accessible in a tax-free manner. Alternatively, if their children change their mind and delay going to school, the cash value can be used in meeting other goals, such as retirement. As an additional benefit, life insurance cash value can be used for a myriad of expenses associated with higher education — travel expenses, and spending money for instance — and it is not limited or restricted to qualified higher education costs.

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