When 529 plans aren't the right choice

The Lifetime Learning Credit allows a deduction of 20 percent for up to $10,000 of college expenses, but it can't be used in conjunction with the American Opportunity Credit. Families can only claim one Lifetime Learning deduction per household, not per child, and have to shell out $10,000 to get the full benefit. So in some cases it makes more sense to stash those funds in a 529 plan instead, Joseph says.

Life insurance

"I recommend using permanent life insurance as a savings tool," says Rodney Ballance, author of "The Love of Money" and host of the nationally syndicated radio show "Ballancing Your Budget." "It grows tax-deferred, you get compound interest on it that doesn't rely on the market and you can use it for college."

Unlike 529 plans, funds stashed in a life insurance policy won't count against a family's financial aid award and policies have no yearly contribution caps, making them attractive to high earners who have maxed out other tax-deferred savings vehicles. Permanent whole life and universal life plans frequently come with guaranteed returns, so families will never lose funds.

According to the financial aid website, policy holders can make withdrawals for college costs but can only withdraw funds they've invested (not earnings) without paying penalties.

Life insurance policies aren't a blanket solution. Costs vary tremendously from policy to policy, but Joseph says insurance can only work if families find a policy with commissions and fees comparable to those of their state's 529 plan. Also, families need to be aware of how the policy works and of any surrender charges that could be incurred by withdrawing funds early, and be prepared to leave their funds in long enough to justify upfront costs.

Before signing on, have your financial adviser run some numbers on how much the life insurance policy will grow before your child heads off to school. Then, compare those figures to the average return rate for your state's 529 plan.


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