A life insurance policy can provide your loved ones with a death benefit should something happen to you. Permanent life insurance can also accumulate a cash value that you can withdraw or borrow while you’re still living. For example, you might use whole or variable life insurance for college savings to pay tuition bills, room and board or other costs. Is using life insurance to pay for college a good idea? There are some pros and cons to consider. Talking to a financial advisor can help you decide on the best way to save for college costs.
Understanding Life Insurance and Cash Value
Life insurance comes in different varieties, but the two main categories are term and permanent life. Term life coverage insures you for a set time period. If you pass away during the term, the policy pays out a death benefit to your beneficiaries that they could use to pay for college or other expenses. If you outlive the term, the policy terminates and no benefit is paid out.
Permanent life insurance, on the other hand, covers you for the duration of your life as long as premiums are paid. Certain types of permanent life insurance can also include a cash value component. As you pay in premiums monthly or annually, part of that premium is deposited into an interest-bearing account. You can then withdraw cash value or take out a loan against it during your lifetime.
Term life, meanwhile, doesn’t build cash value. However, it’s generally less expensive than permanent life insurance coverage. If you’re specifically interested in accumulating cash value with life insurance, you might be able to do that with a permanent whole life, universal life or variable life policy. The main difference between them lies in how the cash value account earns interest.
Can You Use Life Insurance for College Savings?
Yes, if you have cash value in a life insurance policy, you could use it to pay college expenses. There are typically three ways to do that:
- Take a loan against your cash value
- Withdraw cash from the policy
- Surrender the policy
When you get a loan from a life insurance policy, you’re borrowing a lump sum from the cash value. You may not need to pay anything back toward the loan while you’re still living. When you pass away, the remaining loan balance is deducted from the death benefit and any remaining amount is paid to your beneficiaries.
You might choose to withdraw cash instead if your policy doesn’t allow for loans. A withdrawal would allow you to get cash for college or other expenses. Again, the death benefit would be reduced when the time comes to pay out a claim.
The final option is to surrender the policy altogether in exchange for its cash value. If you surrender, the policy terminates and you’ll no longer have coverage. You might choose this option to use life insurance for college savings if you have another life insurance policy as a backup or if you believe you have sufficient assets that make coverage unnecessary.
How to Use Life Insurance for College Savings
If you’d like to tap into your life insurance policy to pay for college, the first step is making sure that you can actually do so. A quick call to your insurance company or a review of your policy documents should tell you whether you have a term life or permanent life insurance policy and if it’s permanent, where there’s a cash value component.
Assuming that your policy has some cash value, the next step is deciding how to go about withdrawing it. Your insurance agent should be able to walk you through the different options. You may also want to talk to your financial advisor to discuss whether it makes more sense to borrow from your policy, withdraw the cash value or surrender it altogether.
If you’re opting for a loan or cash value withdrawal, you’ll need to know how much cash value is available and what amount to withdraw for college costs. You can then make the request to the insurance company to get the cash. Life insurance loans don’t require all the usual hoops associated with personal loans or student loans, though there might be some paperwork you need to fill out.
Once everything is finalized, the life insurance company will cut a check to you for the cash value that you’re taking out. You can then deposit it to your bank and once it clears, use the money to pay for college expenses.
Should You Use Life Insurance to Pay for College?
Life insurance isn’t designed to be a college savings vehicle, per se. Its primary function is to help people leave a financial safety net behind for their loved ones should the worst happen. Life insurance beneficiaries can use the death benefit from a policy to cover a wide range of costs, including mortgage payments, everyday expenses, final expenses and credit card bills.
Education expenses can also be added to that list and there are a few good reasons to consider using life insurance for college savings. Here are some of the advantages of life insurance as a college savings tool.
- It’s flexible since you can withdraw or borrow against your cash value and use it to pay education expenses at your own pace.
- Life insurance policies and any loans you might take from them, typically don’t affect a student’s ability to qualify for financial aid.
- You can continue accumulating interest until you’re ready to withdraw it and you’re not penalized if your child decides not to go to college.
- Coverage is lifelong, which means you could use your cash value to fund college for your children, grandchildren or even great-grandchildren.
There are, however, some downsides to using life insurance for college savings in lieu of a tax-advantaged plan, such as a 529 account or even a Coverdell Education Savings Account (ESA). Here are some of the most important things to keep in mind.
- Cash value can take time to accumulate in a permanent life insurance policy and it’s possible that you won’t have enough to pay for college costs when the need arises.
- A 529 college savings account may offer a higher rate of return, along with tax advantages.
- Permanent life insurance can be more expensive than term life insurance when you factor in the premiums, upfront fees and recurring fees that you might pay.
- Withdrawing or borrowing against cash value shrinks the death benefit that you’re able to leave behind for your loved ones.
A financial advisor might recommend incorporating life insurance into your college savings plan, but as just one piece, not the main focal point. For instance, you might set up a 529 for each of your children and contribute money to it each year that grows on a tax-deferred basis. When your child is ready to go to school, you can withdraw that money tax-free as long as it’s used for qualified higher education expenses.
If you pass away while your child is still in school, your life insurance policy can help to cover any remaining costs to help them finish their education. And if you have a 529 plan but your child doesn’t go to college, you could always transfer it to another beneficiary without a penalty.
The Bottom Line
Using life insurance for college savings is something you might consider if you have a permanent policy. It’s important to consider all the options for funding higher education, including a 529 plan or Coverdell account, to determine what best fits your needs. And if you don’t have a life insurance policy yet, you might want to get a rate quote to get an idea of how much you’ll pay for coverage.
Insurance Planning Tips
- If you’re not sure where to get started with college planning, a financial advisor can help. An advisor can review your financial situation and your student’s estimated needs, then offer solutions for meeting them. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- When comparing life insurance policies, it’s important to consider not only what you’ll pay but how much cash value you might be able to accumulate. Whole life policies, universal life policies and variable life policies can all take very different approaches to growing your cash value.
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