Saving for college tuition is no easy feat. Save too little and your child will be saddled with loans. Save too much and you might not get as much financial aid as you need. Unless you’re planning to pay cash for the full sticker price of a college education, you’re a good candidate for specialized college savings vehicles. One of those is the endowment life insurance policy. Let us explain:
Find out now: How much life insurance do I need?
Endowment Insurance vs Term Insurance
An endowment life insurance policy is a form of life insurance that comes with a guaranteed pay-out (known as an endowment) at the end of a set term. Here’s how it’s different from a regular term life insurance policy: Ordinarily, when the “term” of a term life insurance policy ends, the policyholder doesn’t get money back. The idea of a term life insurance policy is to have relatively low premiums in exchange for peace of mind during the length of the term (generally 10, 20 or 30 years).
An endowment policy takes that model and tweaks it, turning a term life insurance policy into a savings vehicle. Of course, all life insurance comes with a pay-out if the policyholder dies, but an endowment policy pays out at the end of the term even if the policyholder is still alive and kicking. That pay-out can be used to pay for college – or anything else. Because they come with a pay-out, endowment life insurance policies have higher monthly premiums than regular term life insurance policies. Think of them as a cross between a term life insurance policy and a cash-value life insurance policy.
Is Endowment Insurance For You?
When you factor in the high premiums you pay each month, plus inflation over the term of the policy, pay-outs from endowment life insurance policies often don’t provide a particularly high return on investment. They do, however, provide peace of mind and a form of forced savings, since you’ll make regular monthly payments over the life of the policy. And as we know from the dismal average savings rates for Americans, forced saving can be a good thing.
So is it worth it? When deciding how to save for college, consider the return on investment for your money, and how your savings will measure up against the actual cost of four years at college. Then, ask these two important questions:
- How will this impact my child’s financial aid award?
- How will this impact my taxes?
The first year you apply for financial aid (for your child’s freshman year of college), your endowment life insurance policy won’t count against you, and won’t decrease your aid eligibility. That’s an advantage that life insurance policies have over other savings vehicles. Once you take the pay-out, though, that money will count as income when tax season comes around, and will also count as income when you apply for financial aid the following year. You can’t hide from the FAFSA forever.
Endowment Life Insurance vs 529 College Savings Plans
What are some alternatives to endowment life insurance policies? A popular one is the 529 College Savings Plan. 529 plans work differently from endowment life insurance. With a 529 plan, you can make tax-deductible contributions based on today’s college prices in your state, and then withdraw down the road, spending the money tax-free on your child’s college expenses. Unlike an insurance policy, a 529 doesn’t lapse if you don’t make regular contributions, and you can contribute as little or as much (up to a generous cap) as you can and want. Savings in a 529 do count against your family’s financial aid eligibility, though.
The Combo Plan
One solution favored by many parents and financial planners is to combine a term life insurance policy with a 529. That way, you pay low premiums for a big-pay out if something happens to you during the life insurance term, and you’re also benefiting from tax-advantaged college savings via the 529. Taking this approach means splitting up the money you would spend on monthly payments for an endowment life insurance policy. With this strategy you divide that money into two chunks, one to pay the premium on a generous term life insurance policy, and the other to go into a 529 plan.
If you choose the “Combo Plan” (we made that term up, so don’t go requesting it at your next meeting with a financial planner) you’ll have a regular term life insurance policy, meaning you lose the money you pay in premiums if you outlive the term. If losing those premiums sounds too painful, endowment life insurance may be a better option for you. Endowment policies are safe – they’re low-risk and low-reward. You don’t have to worry that fluctuations in the market or the interest rate will wipe out your college savings, and you don’t have to use the endowment for college expenses if you don’t want to. No matter what you’re using the money for, it’s a good idea to wait until the end of the term to claim your pay-out, though, or risk paying penalties and fees for early withdrawal.
Photo credit: ©flickr, ©iStock.com/monkeybusinessimages, ©iStock.com/monkeybusinessimages