Here, for Life Insurance Awareness Month, is an article about a use of life insurance that some financial professionals may not have thought much about.
In a previous article for ThinkAdvisor, we explored the benefits of permanent life insurance and the value of adding protection to your client’s portfolio. With the bull market continuing to roar, it’s important to keep in mind the responsibility you have to ensure your clients are aware of all potential options to help them both protect and grow their retirement assets.
Awareness about these options is a significant issue, as identified in the 2018 Life Insurance Needs Survey from Allianz Life Insurance Company of North America, which was conducted in January. The survey team brought in responses from 803 respondents age 35 through 60, with an annual household income of $100,000 or more.
Although nearly nine in 10 people (88%) understand the death benefit component of permanent life insurance, more than half (51%) said they are unsure or don’t believe cash value from permanent life insurance can be used to assist with other financial needs.
Among these additional financial needs is college funding. It’s no secret that college costs are on the rise. Students are paying an average cost of over $20,000 per year for tuition and room and board to attend a public four-year in-state college or university – and the average cost of attending a four-year private institution is more than $45,000 per year, according to October 2016 data from the College Board.
Thus, lack of awareness about available college funding strategies is noteworthy as nearly 70% of respondents to the Life Insurance Needs survey said they believe the ability to use the funds to pay for college is a valuable feature to consider when purchasing a financial product.
Even when 529 plans, Coverdell Education Accounts and other college funding options are available, many people still find a gap between the available funds and cost of college. So how can you help your clients fill that gap and gain a better understanding of how permanent life insurance can supplement their college funding strategy? These 5 questions can get the conversation started:
1. How can cash value life insurance be used to help fund college? First and foremost, clients should understand that the main reason for buying life insurance is to provide a death benefit for their loved ones in order to replace income or cover final expenses. However, with permanent life insurance — including fixed index universal life (FIUL) insurance — their policy has the opportunity to build cash value, which can be accessed through policy loans or withdrawals for anything they choose, such as college funding. Taking policy loans and withdrawals is dependent on the policy earning sufficient interest to support the strategy.
Of course, whenever a client considers using FIUL as a funding vehicle, the client must understand how FIUL works and get the appropriate disclosures.
Here’s an example of how we might word the disclosures: “Policy loans and withdrawals will reduce the available cash value and death benefit and may cause the policy to lapse, or affect guarantees against lapse. Withdrawals in excess of premiums paid will be subject to ordinary income tax. Additional premium payments may be required to keep the policy in force. In the event of a lapse, outstanding policy loans in excess of unrecovered cost basis will be subject to ordinary income tax. If a policy is a modified endowment contract (MEC), policy loans and withdrawals will be taxable as ordinary income to the extent there are earnings in the policy. If any of these features are exercised prior to age 59 ½ on a MEC, a 10% federal additional tax may be imposed. Tax laws are subject to change, and the client should consult a tax professional.”
2. What are the benefits to using loans from my life insurance policy as part of a college funding strategy? There are several benefits from utilizing loans from a life insurance policy, including: tax advantages (the death benefit is generally income-tax-free when passed on to beneficiaries), tax-deferred accumulation, and income-tax free loans); flexibility (your client can access their policy’s cash value for whatever they want and for any purpose they choose); eligibility (the money received through policy loans generally won’t affect the student’s eligibility for other financial aid); simplicity (accessing their policy’s cash value is as simple as requesting a loan or withdrawal); and control (only your client can access their policy’s cash value and decide how their policy loans or withdrawals are used). If the policy is fully surrendered, surrender charges may apply. For partial surrenders (withdrawals), partial surrender charges may also apply.