The VUL Option For College Funding Might Be Right For Your Clients

As a father of a six-year-old girl and a three-year-old boy, college seems like some far away event, and is consequently low on the priority scale. Right now, Im focused on ballet lessons, soccer games, Barbie and matchbox cars. But the reality is that I have only 12 and 15 years, respectively, to save for that magical day–that I still remember so well–when my children move into their freshman dorms. Many of your clients find themselves in the same situation.

Even in todays dollars, the cost of a four-year college education is frightening. According to the College Board, this years average cost for students enrolled in private colleges and universities, including tuition, fees, room and board, books, travel, and incidental expenses equals $27,677. So, by the time my daughter enters college in 2015, the cost of a year at “Private U” (assuming a 6% annual increase) will set me back a mere $55,691. If I adjust for the next three years after matriculation, the bill for four years will be $243,629.

Furthermore, recent reports state that many public universities are raising tuition by 20% to 40% (for a second straight year) this fall.

The Latest and Greatest: 529 Plans. The 2001 tax act significantly enhanced the appeal of Section 529 qualified tuition programs. Notably, distributions made from the state maintained qualified tuition programs to pay for qualified higher education expenses are excludable from gross income. Likewise, distributions made beginning on or after Jan. 1, 2004, are excluded from gross income for qualified tuition programs established and maintained by an entity other than a state.

A contribution to a qualified tuition program qualifies for the $11,000 annual gift tax exclusion as well as an election to spread the gift ratably over five years. Therefore, a married couple can contribute up to $110,000 ($55,000 for a single person) in a single year on behalf of an individual and still avoid gift taxes.

Additionally, it is now easier for grandparents to fund their grandchildrens education since they are able to change beneficiaries among their grandchildren without restriction.

The Variable Universal Life Option. Variable universal life has long been touted as a tool with so much flexibility it can solve many problems. One of the problems this product can be used to address is that of college funding.

First, this caveat: Due to fees, expenses and the fact that values may fluctuate, the VUL policy is inappropriate for college funding if the time horizon is less than 10 years. For those clients with a shorter time horizon, 529 plans and/or other investments are more appropriate.

But for clients with young children or grandchildren, VUL offers numerous advantages. First and foremost, life insurance carries a death benefit. If the insured is someone that can be used other than the student, the death benefit may provide an immediate funding mechanism to help pay for education costs. The policy proceeds, of course, escape taxation entirely when they are delivered as a death benefit. This death benefit is received by the policy beneficiary and is excluded from the beneficiarys income.

Second, if the insured does not die and if the policyholder is the future student, he or she may continue to carry a permanent life insurance policy after paying for education costs. Likewise, if someone other than the student is the policyholder (i.e., a parent or grandparent) that person may retain the policy to use for such things such as a retirement supplement or for other financial planning needs.

In the 529 Plan, whoever is controlling the plan controls the investment options. Once an investment choice is made, it can roll over from plan to plan only once a year, if the rollover is for the same designated beneficiary.

Most variable universal life insurance products permit the owner to choose among investment choices and make tax-free transfers between investment choices. In many cases, multiple transfers within a year may be allowed.

Finally, and perhaps most importantly, there is a great financial aid advantage. The federal government determines the amount of financial aid the student may receive by applying a particular formula consisting of four factors: parents income, parents assets, students income, and students assets. This is found in the U.S. Department of Education FAFSA form. The formula allows for the exclusion of certain assets, one of which is the “cash value or buildup of equity of a life insurance policy.”

Simply put, life insurance assets are invisible to college aid affairs. That means that when it comes time to evaluate their eligibility, your clients children would not be penalized for their well-thought-out savings plans that you recommended. Because the government has deemed cash value an excluded asset, using life insurance as the college savings vehicle could help the child qualify for more financial aid. Section 529 plan assets are not excludable for financial aid purposes.

One planning strategy particularly can be effective here. A grandparent would be the owner and beneficiary of a life insurance policy. When the grandchild attends college, the grandparent would make tax-free withdrawals to pay for tuition (assuming the policy is not a modified endowment contract and assuming values are sufficient). The strategy is to have the grandchild as the insured, keeping the cost of insurance down so that cash value can be maximized.

It is also significant to note that the grandparent also retains control of the money at all times, and the money does not have to be used to fund college expenses to retain tax-advantaged status. So, if Junior chooses to join a rock band over attending an Ivy League school, Grandma wont be penalized if she uses the money elsewhere. Keep in mind, however, that some state limits may apply to policies taken out on minors.

Finally, keep in mind that what Congress gives, Congress can take away. The entire Economic Growth and Tax Relief Reconciliation Act of 2001 “sunsets” in 2011. Consequently, unless lawmakers act between now and then, earnings on 529 plans will revert to being merely tax-deferred. While Congress may well make the change permanent, clients who expect their children to attend college after 2010 should be aware of this provision.

Daniel J. Munroe, JD, CLU, is director of advanced marketing for MONY Partners, Hartford, Conn. He can be reached at dmunroe@mony.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 25, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.