Life insurance or 529 for college savings?

Saving for your child’s education is one of the biggest financial moves you’ll make as a parent, but what’s the best way to go about it? You’ve probably heard of 529 plans designed specifically for education savings, but did you know cash value life insurance can also be a tool for funding college? These two options work very differently, and choosing the right one can make a big impact on your financial future.

In this article, we’ll break it down for you — whether a 529 plan’s tax advantages or the flexibility of a life insurance policy might be the better fit for your family. We’ll explore how each works, what they offer and, most importantly, which might help you save smarter for those looming tuition bills.

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Whole life insurance combines life insurance with an investment component.

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What is a 529 plan?

A 529 plan is a tax-advantaged savings account specifically designed to help families set aside money for education expenses. One of the biggest benefits of 529 plans is that the earnings grow tax-free at the federal level, and many states also offer additional state tax benefits, such as deductions or credits on contributions. While 529 plans are state-sponsored, you don’t have to pick a plan from your state. Additionally, these plans aren’t just for parents; anyone can open a 529 plan for a child, whether you’re a grandparent, relative or even a family friend.

529 plans are flexible when it comes to contributions. There are no strict minimums, so you can start with whatever amount fits your budget. Contribution limits, however, are generally quite high, with many plans allowing contributions ranging from $235,000 to $575,000, depending on the state. This makes 529 plans an enticing option whether you’re saving a little at a time or planning for a significant investment in your child’s education.

There are two main types of 529 plans: savings plans and prepaid tuition plans. Let’s break down how each works.

Savings plan

Savings plans are the more common type of 529 plan. These plans work similarly to a traditional investment account. The account holder contributes money, which is then invested in mutual funds, ETFs or other investment options, depending on the plan. Over time, the account grows based on the performance of those investments, and the funds can be withdrawn tax-free when used for qualified education expenses.

Qualified expenses include tuition, room and board, books and even some K-12 expenses. The flexibility of savings plans makes them a great option if you’re not sure where your child will attend school or if you want to cover a broad range of educational costs.

Prepaid tuition plans

Prepaid tuition plans, on the other hand, allow you to lock in today’s tuition rates at participating in-state public colleges and universities. Essentially, you’re buying future tuition credits at current prices, which can protect you from the rising cost of education. However, these plans are more limited in terms of where they can be used, as they’re typically tied to specific schools or state programs.

Prepaid tuition plans aren’t available in every state, and not all schools participate, so it’s important to check your state’s offerings. While they can provide a hedge against future tuition hikes, they may not cover other education-related expenses like room and board, which makes them less flexible than savings plans.

Who has control over a 529 account?

The control of a 529 plan rests with the account owner, typically an adult such as a parent or grandparent. While the account is meant for a specific beneficiary — like a child or grandchild — the account owner maintains control over the funds. This includes decisions on contributions, withdrawals and investment choices. However, when the beneficiary reaches the age of 18, the account owner has the option to transfer ownership of the account if they wish. Otherwise, the original owner retains control, even as the child becomes an adult.

What are the pros and cons of a 529 Plan?

A 529 Plan offers numerous benefits for saving toward educational expenses, but it’s not without its potential drawbacks. Let’s break it down:

Pros

• Tax benefits: Contributions grow tax-deferred, and withdrawals for qualified education expenses are tax-free. Some states also offer tax deductions or credits on contributions.
• High contribution limits: Many states allow significant contributions, often well beyond the cost of a four-year college education.
• Flexible use: Can be used for a wide range of educational expenses, including tuition, books and even room and board. It can also be applied to K-12 education and student loan repayment.
• Control: The account owner retains control over the funds and can change the beneficiary if needed.

Cons

• Penalty for non-educational use: If the funds are not used for qualified education expenses, withdrawals face a 10 percent penalty and income taxes on earnings.
• Limited investment options: Your investment choices are often restricted to those provided by the state’s plan, which may not offer the most diverse or competitive options.
• Impact on financial aid: A 529 plan owned by the student or parent can affect financial aid eligibility, as it’s counted as an asset.

What counts as a qualified 529 expense?

Qualified 529 expenses are those that align with the IRS guidelines for educational purposes. These include:

• Tuition and fees: Expenses directly related to enrollment or attendance at a qualified institution.
• Room and board: This applies if the student is enrolled at least half-time, and the costs can’t exceed what the school allows in its official cost of attendance.
• Books, supplies and equipment: Items required for a student’s classes are considered qualified expenses.
• Computers and software: As long as they are used primarily for educational purposes, they are eligible expenses.
• K-12 tuition: You can use up to $10,000 annually for K-12 private or religious school tuition.
• Student loan repayment: Up to $10,000 can be used to repay student loans for the beneficiary or their sibling.

What if my child doesn’t go to college?

If your child decides not to attend college, you have several options about what to do with the funds in your 529 plan:

• Change the beneficiary: One of the most flexible aspects of a 529 plan is the ability to transfer the funds to another qualified family member, such as a different child, spouse, sibling, niece or nephew.
• Rollover to a Roth IRA: As of 2024, thanks to the SECURE 2.0 Act, unused funds in a 529 plan can be rolled over into a Roth IRA for the beneficiary, subject to a $35,000 lifetime limit and annual IRA contribution limits. This option can provide a valuable retirement savings boost if college isn’t in the cards.
• Withdraw the funds (with penalties): If neither of these options works for you, you can always withdraw the funds for non-educational purposes. However, you will be subject to income taxes on the earnings and a 10 percent penalty.

What is permanent life insurance?

Permanent life insurance is designed to provide coverage for your entire lifetime as long as you continue to pay the premiums. Unlike term life insurance, which covers a set period, permanent life insurance typically pays out a death benefit no matter when you pass away. These policies typically remain in force until age 95 to 121, depending on the terms.

In addition to the guaranteed death benefit, permanent life insurance policies build cash value over time. This cash value can be accessed during your lifetime through loans or withdrawals, though any outstanding loan or withdrawal will reduce the death benefit paid to your beneficiaries.

Whole life insurance

Whole life insurance is a straightforward form of permanent life insurance. One of its key features is fixed premiums, meaning your payments stay the same over time. Additionally, whole life policies offer guaranteed cash value growth at an interest rate set by the insurer, providing a steady accumulation of value over the years. Participating whole life policies may also pay dividends.

While whole life insurance provides lifelong coverage, it tends to be less flexible than other types of policies, but the predictability of premiums and guaranteed cash growth makes it appealing to many.

Universal life insurance

Universal life (UL) insurance is a flexible form of permanent life insurance that allows policyholders to adjust both the death benefit and premium payments over time. UL offers multiple types, including:

• Indexed universal life (IUL)
• Variable universal life (VUL)
• Guaranteed universal life (GUL)

Each type offers varying degrees of risk and potential cash value growth depending on how the cash value is invested or linked to market indexes.

In addition to taking out policy loans, universal life insurance policies also allow policyholders to make withdrawals from the cash value. However, it’s important to note that both loans and withdrawals can reduce the death benefit if not repaid or if too much is withdrawn.

Variable life insurance

Variable life insurance is yet another type of permanent life insurance. With this policy, you can choose from a variety of subaccounts, typically tied to stock and bond funds, but this type of insurance shifts the investment risk to the policyholder. These subaccounts allow the policy’s cash value to grow or decline based on market performance.

While this offers the potential for higher returns compared to other life insurance types, it also means that the value of your policy is subject to market fluctuations, and poor investment performance could reduce both the cash value and potentially the death benefit.

Using life insurance for education expenses

Life insurance can play a unique role in planning for education expenses, though its effectiveness depends on how it’s structured. There are two primary ways life insurance policies might help in this scenario: through the death benefit and through cash value loans or withdrawals.

• Death benefit: In the event of a policyholder’s passing, the death benefit is paid out to beneficiaries, and it can be used for any purpose, including education costs. This is the primary way life insurance can safeguard against the loss of income or ensure that a child’s educational future is secure.
• Cash value loans or withdrawals: Permanent life insurance policies like whole life or universal life accumulate a cash value over time. Policyholders can borrow against this cash value or, if their policy allows, make withdrawals to cover education expenses. However, loans must be repaid with interest, or they will reduce the death benefit. Withdrawals, on the other hand, permanently reduce both the cash value and the death benefit.

Parent vs. child policies for education savings

Parents can buy life insurance policies for themselves or their children. However, buying a policy for a child generally won’t accumulate enough cash value to significantly reduce education expenses.

• Parent policy: When parents purchase whole or universal life insurance on themselves, they can build significant cash value over time. This value can potentially be tapped to help fund a child’s education.
• Child policy: While a whole life policy on a child has low premiums, the cash value it builds is typically minimal. Even if ownership is transferred to the child later, the accumulated value likely won’t be enough to cover substantial education costs, making this option less effective.

What are the pros and cons of using permanent life insurance for college?

Using permanent life insurance to save for college has its perks and its pitfalls. It’s flexible and can be a useful financial tool, but it’s not the same as a 529 plan.

Pros

• Flexible funds, no strings attached: One of the biggest advantages of permanent life insurance is that you can use the cash value for anything, not just education. If your child decides not to go to college, you’re not stuck with penalties or taxes like with a 529 plan.
• Not just for tuition: Whether you need to cover emergencies, pay down debt or even boost your retirement savings, the cash value can be tapped for anything you choose, giving you more control over your money than a 529 plan.
• Tax-free withdrawals and loans (up to what you’ve paid in): You can take out loans or make withdrawals without paying taxes as long as you stay within the amount you’ve paid into the policy (also called your “cost basis”). Once you exceed that, any earnings may be taxed, so it’s important to keep track.
• Doesn’t mess with financial aid: The cash value in a permanent life insurance policy usually isn’t factored into financial aid calculations. This means your child could still qualify for financial aid, even if you’ve built up a decent cash value in the policy.

Cons

• No tax deductions: Unlike a 529 plan, you don’t get any tax breaks for contributing to a life insurance policy. While 529 contributions may qualify for certain tax deductions, life insurance premiums do not.
• It’s not cheap: Permanent life insurance comes with high costs. There are initial fees, ongoing expenses and insurance charges. Plus, it can take 10 years or more just to build up enough cash value to borrow against.
• Borrowing isn’t free: While you can borrow against the cash value, you’ll have to pay interest on the loan. Plus, if you don’t pay it back, it reduces the death benefit your beneficiaries would receive.
• Qualifying for coverage: Unlike a 529 plan, getting a life insurance policy requires the insured person (usually the parent) to qualify based on health and age. However, the good news is that the child doesn’t need to be the insured. The parent can take out the policy, build cash value and still use it to help cover college costs.

In short, permanent life insurance offers flexibility with how you use the cash, but it’s more complicated and costly than a 529 plan. If you’re primarily saving for education, a 529 might be the simpler, more efficient option — but if you like the idea of having money you can use for other purposes and have a need for life insurance, permanent life insurance could be worth considering.

Which is a better investment to pay for college?

Deciding between a 529 plan and permanent life insurance for college savings will typically depend on your goals and needs. Here are some quick scenarios to help guide your choice:

• If you want tax advantages and focused college savings: A 529 plan is ideal. It offers tax-free growth, and withdrawals for education expenses are penalty-free. Plus, many states provide tax breaks on contributions. If you’re certain about saving for college, this is the simpler and more direct option.
• If you want more flexibility for broader financial goals: Permanent life insurance could be a better fit. It allows you to build cash value that can be used for any purpose, not just education. This could be helpful if your child might not go to college or if you want to cover other major expenses. Just remember that the costs are higher because you are also paying for life insurance, and cash value takes time to build.
• If you need a balance of security and savings: You could use both — a 529 plan for dedicated college funds and life insurance for additional flexibility and family protection.

In short, 529 plans are great if you’re focused on education savings, while life insurance offers more flexibility if you want to cover other financial needs too.

Frequently asked questions

• What expenses can I pay for with my 529 savings account?

  Generally, you can use the money from your 529 plan for anything related to your education, including tuition, fees, books and supplies, on-campus room and board, computers, software, and some expenses if you live off-campus.

• If I take an education loan from my life insurance policy, are there long-term implications?

  Yes. Taking a loan from your life insurance policy, no matter what you use the money for, will mean that the potential death benefit is likely reduced until you pay back the loan. Your insurer uses the policy as collateral for the loan, and they will add interest payments to the money that you’ve borrowed.

• Can savings from a 529 plan be used for something other than college?

  Money from a 529 plan must be used for education expenses but does not have to be used specifically for tuition at a four-year university. The savings can be used for any type of education, including community colleges, technical schools, vocational and certificate programs, and more. These savings also do not expire, so if you choose to return to school later in life, the money is still available to you.