Endowment life insurance is a specialized insurance product that's often dressed up as a college savings plan—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.
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 be the college savings plan you've been looking for? Let's look at whether the stated advantages of these policies live up to their promises.
Endowment Life Insurance Provides Two Products for the Price of One
Marketing materials for endowment life insurance might make it seem like you're saving money by bundling products, but that's not the case. Term life insurance, the type included in an endowment life policy, is inexpensive if you're young and healthy. 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 would get more college savings and more insurance for the same amount of 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 is going toward your savings goal. Some of it is going toward buying insurance.
Endowment life insurance policies do not have investment risk or interest rate risk. But when you choose incredibly safe investments, they usually offer incredibly low returns. Playing it this safe means you won't accumulate enough savings to pay for college. Your savings may not even keep up with inflation, especially since the earnings on endowment life insurance policies are taxable. There are two better options than an endowment life policy, however, and they both allow you to minimize your risk. The first is a prepaid tuition plan, which lets you lock in today's tuition prices for future education expenses. This plan eliminates the risk you won't have the money for your child's education when the time comes by allowing you to pay for it well in advance. It should also greatly reduce the cost of that education.
529 Savings Plan
The second better option is a 529 college savings plan, where you can choose how much investment risk to take. 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. For example, to obtain the Gerber Life College Fund policy, a medical exam isn't required unless you're 51 or older and applying for $101,000 or more in coverage. This advantage means an endowment life insurance policy could look like 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.
It Forces You to Save for College
Unlike a 529 plan or Coverdell ESA, endowment life insurance it isn't 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. Manulife Financial, one of the largest life insurance companies in the world, doesn't mince words on its website. It says that endowment life insurance "provides a systematic way of saving for people who are extravagant."
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.