The Truth About Endowment Life Insurance Policies

Endowment life insurance is a specialized insurance product that's often dressed up as a college savings plan. The endowment life insurance policy promises a risk-free, guaranteed return on a guaranteed date as long as you make the fixed monthly payments. What's more, the cash value isn't counted against your child's financial aid eligibility. Could this life insurance be the type of college savings plan you've been looking for?

Let's look at whether the stated advantages of these policies live up to their promises.

Basically these policies couple term life insurance with a savings program. As the policyholder, you choose how much you want to save each month and when you want the policy to mature. Based on your monthly contributions, you're guaranteed a certain payout, called an endowment when the policy matures.

You can then use this endowment for your child's college tuition, fees, books, living expenses, and other costs. If you should die before the policy matures, your child will receive the payout as your death benefit and will still have the anticipated money for college.

Are Two Products for the Price of One the Best Option?

Marketing materials may suggest endowment life insurance saves you money by bundling products. But is that the case?

Term life insurance, the type included in an endowment life policy, is inexpensive for young and healthy customers. If you broke up your monthly payment to the endowment life policy and used part of it for college savings and part of it for term insurance, you'd get more college savings and more insurance for the same money. Endowment life insurance is certainly not the only life insurance product that combines savings with insurance.

However, if your primary goal is to accumulate savings, these types of policies usually aren't the best option because not all of your money goes toward your savings goal. Some of it goes toward buying insurance.

Risk-Free May Not Help Long-Term Savings Goals

Endowment life insurance policies don't have investment risk or interest rate risk. The flip side is that low-risk investments usually offer poor returns. In other words, you won't save enough to pay for college. Your savings may not even keep up with inflation, especially since the earnings on endowment life insurance policies are taxable.

These plans should slash tuition costs by permitting parents to pay for college years early and avoid price hikes. One potential drawback, however, is that many of these arrangements are only valid for a state school in your home state at the time you opened the account. That's not necessarily a bad thing, but no one can predict what your and your child's preferences might be in the future

529 Savings Plans

The second option is a 529 college savings plan, which permits you to choose how to invest your savings. Ideally, you would invest a portion of your savings in stocks and a portion in bonds, gradually moving away from stocks as your child approaches college age. This strategy is similar to how you save for retirement—you take more risk at the beginning when you have a long time horizon, and as the day when you need the money approaches, you move into lower-risk investments to make sure the money you need will be there when it's time to spend it.

If you're truly risk-averse and are willing to accept lower returns, you can also avoid investment risk with FDIC-insured money market accounts, savings accounts, and CDs. Regardless of the investment you choose, a college savings plan will help maximize your returns by minimizing your tax liability.

With the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act, there are now more reasons to look at 529 plans favorably. The SECURE Act has increased what 529 plans can be used for by expanding the definition of "qualified higher education expense." You can now use a 529 plan to pay for certain expenses associated with registered apprenticeship programs. This includes fees, books, supplies, and equipment as long as the apprenticeship program your child is enrolled in is certified by the Secretary of Labor. The SECURE Act also allows you to use up to $10,000 of your 529 savings to pay the principal and/or interest on your child's qualified student loan debt.

It Doesn't Count Against Financial Aid Eligibility

Both 529 plans and education savings accounts effectively lose 5.6% of their value when students go to college. The FAFSA takes this money into account and increases the student's expected college contribution by up to 5.6%. It's important to understand how your savings and investment decisions will affect your child's financial aid eligibility, so you don't anticipate aid you won't qualify to receive.

Endowment life insurance doesn't count against a student's financial aid eligibility the way other college savings vehicles do. But this "advantage" still isn't a good reason to choose an endowment life insurance policy. Even after the 5.6% hit they take, 529 plans and ESAs when used wisely will give you more bang for your college investment buck than endowment life insurance can.

You Don't Need a Medical Exam

Unlike many life insurance policies, you don't need to submit to a medical exam to qualify for an endowment life insurance policy. This advantage means an endowment life insurance policy might be a good option if you have a medical history that would prevent you from qualifying for an exam-contingent policy. It's also good news if you'd rather avoid the time and unpleasantness of the exam and its associated questions about your medical history.

However, you can also take out an ordinary term policy without an exam. This feature isn't unique to endowment life policies. Keep in mind, though, with any no-exam life insurance, the policy's face value will be relatively small—enough to help a little, but probably not enough to meet every need you're trying to provide for.

Take a Second Look Before Buying

Unlike a 529 plan or Coverdell ESA, endowment life insurance is not a college savings plan, it's just marketed that way. It's just life insurance, and the payout can be used for anything without penalty.

No financial product can fully protect you from yourself if you're extravagant. For example, you can take a loan out against your endowment life policy, and if you do, your benefit will be reduced by the outstanding loan amount and the interest you owe on that loan. You also won't receive the entire benefit if you don't pay your premiums in full, and if you stop paying your premiums, the policy will lapse. Because of these options, endowment life insurance doesn't offer any protection against bad spending choices you or your child might make.

The Bottom Line

Endowment life insurance policies sound like a great way to save for college, but they pale in comparison to your other options. They don't offer enough insurance or enough college savings to meet most people's needs, and they don't give you the most bang for your buck.