What is a better vehicle for saving for my child's education costs: a whole life insurance policy or a 529 plan?
I'm considering the possibility of using whole life insurance for two purposes. I want to protect my family with life insurance, and I want to start saving early for college costs for my 3-year-old son. My other option for college savings is to open a 529 plan. What will happen if he does not go to college?
Of the options here, for most I would choose neither.
Life insurance is better used as insurance than as an investment. If you don't have a permanent insurance need (and most don't) then what you need is low-cost term insurance.
For further thoughts on the problems with a 529 today, see my article here on Investopedia.
For most, I look first at if we are taking advantage of workplace plans. Then, IRA and specifically Roth IRA opportunities. For just about all, this is a better option for saving with the possibility of using for college.
Most also do not consider along with the increasing costs, there is a declining value of traditional colleges and technology possibly changing options in the future. As that happens states will try to prop up the system (by offering free colleges to those who did NOT save to a 529). We see it happening already today in states like New York.
Along with that, you have increasing income that you will be able to use cash flow to assist. And, let's say your income does not increase - is your money today better saved for your retirement and not relying on your children in retirement, or by saving for 15 years for a goal that may not even exist in 15 years due to his choices or lower cost options.
The next 18 years will bring significant changes to college and education. Wrapping up your money in an insurance contract or state-run 529 plan that you have very little control over may not be your best move. These are tools that could have value. I don't work with those though that these are among the first places that I would consider.
While a good whole life insurance product could be used, and has its perks, it's necessary to think about the costs of higher education in your location. Will the cash value of your life insurance be enough to cover the costs that you would like to cover for your son in the fifteen or so years that you have until he enters college? The cash value of a whole life insurance policy can take a considerable amount of time to build up to an amount suitable for education costs which, according to the College board for 2017-2018, tuition and fees per year are now $34,740 for private college, $9,970 for state residents at public colleges, and $25,620 for out-of-state residents attending public universities. 529 plans carry a greater risk-reward factor because you are invested in the market instead of being invested in the insurance company’s general portfolio but fees for a 529 plan are going to be less than for whole life insurance. In addition, if your son does not go to college, some states allow for you to now take up to $10,000 from 529 plans to pay for K-12. If he does not attend private school nor has a desire to attend college you are able to change beneficiaries, if you had another child you could apply it to their schooling. However, if you wish to withdraw the funds, there will be a tax penalty of 10% plus you may have to pay federal and possibly state taxes on the earnings portion.
A high quality permanent life insurance policy can be an effective way to save for college for younger children. The cash value will not be counted in the financial aid process at most colleges, while the value of a 529 plan could reduce an award the family would otherwise receive. If properly structured, the cash value can be borrowed to pay college costs. If the student does not go to college, the funds can continue to grow inside the policy or be used for any other purpose, e.g. buying a home. If you fund a 529 plan and the student does not go to college you may transfer the plan to another family member, or withdraw the funds and pay the 10% penatly and tax on the gains, if any. The new tax code now allows 529 plans to be used to pay private k-12 expenses, where previously this was not allowed.
I will answer this question from the point of view of somebody who sells life insurance. You can compare my notes to somebody who sells the 529 plans, and see which recommendation is most suitable for you.
Here is the value a whole life product would bring to you:
A permanent, guaranteed death benefit. If you buy enough coverage now, you may never have to buy another policy for the rest of your life. This is a biggie since you may unfortunately not be insurable at a reasonable price later on in life.
Extremely strong guarantees. There is probably not another product in the marketplace that can match the guarantees of whole life insurance.
Substantial non-guaranteed cash accumulation. Given enough time, the right carrier will pay you substantial dividends. These can accumulate into attractive sums in your policy. The key is giving the policy enough time to do this. Is the time horizon for college funding enough time? That question can easily be answered with an illustration by the agent proposing the product to you. Take a look at the expected cash value in the years you will need to pay those bills, and see how much money you would have. Bear in mind that these numbers are projected, and not guaranteed.
The best savings vehicle for education is a 529 account. It was created for the purpose of education savings. Whole life is first and foremost, life insurance. From what you've expressed, " I want to protect my family with life insurance, and I want to start saving early for college costs for my 3-year-old son." Your best option is to buy term insurance, and then open a 529 account for your son. The cash values in a whole life policy typically take at least ~15years to break even; meaning having more cash value than premiums paid. And then at that point, you're faced with either borrowing the cash values or surrendering the policy. If minimizing debt from college is a goal, then borrowing from the cash values doesn't make any sense. Your best bet is to open a 529 account now, and invest the money quite aggressively for the next few years and then begin to dial back the risk as your son ages. Doing so, you can capture market growth in a tax-advantaged vehicle and don't need to jump through hoops to access your money, like you would with a whole life insurance policy. Hope this helped!