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The life insurance college savings bank

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The cost of post-secondary education has soared in recent years and, much like health-related expenses, shows no sign of dropping anytime soon. Though your clients may be well aware of the many benefits associated with investing in life insurance policies, they may not be aware of the possibility of using life insurance as a college savings tool. Parents looking for ways to fund their children’s college expenses have often looked to 529 savings plans or Coverdell education savings plans. While these accounts can be beneficial, use of life insurance as a savings alternative may provide benefits that are impossible to realize through traditional savings vehicles.

Life insurance as college savings: The basics

Clients have long looked to life insurance policies as tax-preferred investment vehicles because many whole life-type policies allow the client to take tax-free loans against the cash value of the policy.

The client can purchase a whole life policy today and use the built-up cash value that the policy will accumulate over the years to fund college expenses at a later date. The withdrawal against the cash value in the policy is taken tax free, and the client can use those funds to finance any expense he chooses — even living expenses that may not be eligible for tax-preferred treatment under a traditional education savings plan.

Of course, the longer the cash value in the policy is permitted to accumulate, the larger it will become, so this type of savings vehicle is usually best for clients who have several years until their children will begin college.

Life insurance or 529 plan?

A life insurance policy that is used as a savings plan for college education expenses obviously maintains the tax benefits that it would otherwise carry, but also has an added perk: life insurance is not counted along with the client’s other assets in determining financial need. Excluding the value of the life insurance savings account from the calculation of a client’s ability to pay can allow the student to tap into financial aid sources that would otherwise be unavailable, thus reducing the cost of college for the client.

Further, traditional 529 educational savings plans require that the funds eventually be used to pay for qualified educational expenses in order to reap the associated tax benefits. If the child decides to forego a traditional college education, the client may even be required to pay back taxes if he has taken state tax deductions in prior years, along with a 10 percent penalty on the earnings in the account. Conversely, life insurance can be purchased today, and there are no restrictions on how the funds are used in order to maintain the tax benefits associated with the policy.

Traditional savings plans also fluctuate with the market, so there is an element of risk involved. There is no way to tell how much cash will be available when college expenses eventually start to accrue. Some of this risk can be eliminated with certain life insurance policies that offer guaranteed returns, if the client has sufficient time to wait for these returns to begin adding to the cash value of the policy. Often whole life policies earn very little in the first few years, so unless the client has sufficient time to allow the cash value to accumulate, there may not be enough to draw upon when needed.

The downside to using a life insurance policy as a savings plan is that the fees associated with the policy can be greater than those imposed on a 529 savings plan. It is also important that clients are given a realistic portrayal of the anticipated rate of return that can be achieved through investment in life insurance — today’s low interest rate environment has led to many policies earning at a much lower rate than anticipated when they were purchased.


While life insurance may not be the perfect college savings tool — requiring planning years in advance so that the cash value in the policy has time to accumulate — it can provide powerful tax benefits for your clients with minimal risk. If the college expenses never materialize, none of the tax benefits associated with life insurance ownership are lost, and the funds can be used as the client chooses.

For more on life insurance and saving for college, see:

Keep participating whole life on your short list

Four questions, one answer: life insurance

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