college

Life insurance or 529 for college savings?

Round 3: financial aid

One of the major advantages to using a cash value policy for college savings is that money in an insurance plan won't reduce your financial aid. Money in a 529 college savings plan can subtract up to 5.6 cents in aid for every dollar stored in the account, but cash value policies are sheltered from the federal financial aid formula, according to the Department of Education.

"If families take money out of a life insurance policy for college, they need to do that as a loan," says Van Meter.

Van Meter also says that taking a loan against a life insurance policy won't count against your financial aid but will reduce your death benefit. Cashing a policy out entirely will count as income and can reduce your aid package by up to 47 percent and could incur surrender charges.

Families with low assets are already protected from losing federal financial aid dollars. According to the Department of Education, families can hold up to $74,000 in assets -- including real estate outside the primary home, stock market investments, savings accounts and college saving vehicles -- without impacting their federal aid. Exactly how much depends on the age of the oldest parent.

Round 4: cost

Section 529 administrative and advisory costs can range from 0.25 percent to 1.85 percent according to Morningstar, but charges on cash value insurance policies can easily top 2 percent, says Kuhner. To reduce the costs, Kuhner advises families to insure the student rather than listing him or her as the beneficiary.

"The mortality charges are going to be much less," he says, adding that policies for young, healthy kids are substantially cheaper than those for adults.

Besides paying higher administrative and advisory costs, Peter Laurenzo, a Certified Financial Planner and president of College Aid Planning Associates Inc. in Albany, N.Y., says parents saving for college in an insurance policy won't get a state income tax deduction that many 529 holders receive.

"In a New York 529 plan, (families) get a state tax deduction up to $5,000 per parent," he says. "That's significant."

However, not every state offers a 529 deduction and most that do only offer it to residents invested in that state's plan.

Before enrolling in a life insurance or 529 plan, comparison shop and have a financial adviser crunch the numbers to see whether the no-risk returns of a life insurance plan outweigh the costs and lost tax deduction.

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