529 Essentials: 529s vs. Insurance Products

This week, we will compare and contrast 529s and insurance products for college financial planning.

Two Basic Types of Investment Vehicles Designed for Protection: 529s and Insurance Products. While insurance products are known for protection against something happening such as life insurance in case of death, 529 college plans can also be positioned as protection against tuition inflation. For example, the greater the future cost of higher education, the more important 529s are in helping families with college affordability. Additionally, 529s and insurance products allow families to save money for education with tax exempt asset growth. This week, we discuss those types of insurance products that provide a cash value so that the assets can be used to pay for higher education. One example of this would be whole life insurance, where the purchaser owns the insurance and builds up equity in the policy (called the cash value) as premium payments are made, and a portion of the cash value can be accessed at a later point in time in the form of a tax-free withdrawal and/or loan. For simplicity, this article will stay centered on using the vehicles to pay for higher education, as opposed to the merits of using insurance products with a cash value as an emergency fund, as a cash accumulation vehicle for non-education related goals or for its traditional purpose of life insurance. That being said, the next section on market sizing notes the high volume of assets earmarked in insurance products with a cash value for college financial planning, given the value of liquidity and flexibility in the current volatile marketplace and overall economy. Therefore you as an advisor can provide value by knowing these differences in investment vehicles, selecting the right investment vehicles based on the unique needs of your clients, and knowing how to customize the use of different vehicles to achieve the unique financial goals and needs of your client.

Market Sizing: As of December 2015, 529s allowed 12.7 million families to save over $253 billion in assets based on data by Strategic Insight. Of that, 11.6 million families saved over $230 billion in 529 savings plans while 1.1 million saved over $23 billion in 529 prepaid accounts. In addition to the $253 billion in 529s, families have saved approximately $32 billion in insurance products with a cash value as of December 2015 for college financial planning. This $32 billion represents a 28% increase compared to $25 billion as of December 2014. This increase is both due to volatility driving investors to seek protection that also provides some relief for college financial planning, in addition to the decrease in alternatives such as cash and other banking products given the current interest rate environment. Therefore assets in 529s and insurance products with a cash value earmarked for college financial planning increased on a year-over-year basis.

Compare and Contrast:

—Income Limit: 529 plans and insurance products with a cash value do not have an income limit, though the accountownwer of the insurance product would need to qualify for the plan.

—Age Restrictions: 529 plans and insurance products with a cash value do not have an age restriction. Generally, age does impact the pricing of insurance products though does not restrict the use of the product. As such, the accountowner of the insurance product would need to qualify for the plan

—Contribution Limits: 529s allow investors to contribute up to the annual gift taxing limit of $14,000 per year per account-owner beneficiary relationship, or $28,000 per joint filing married couple as of 2016. Additionally, 529s allow an accountowner to make five years of gifting in one year such as $70,000 per single filer or $140,000 per joint filing married couple. Lastly, 529s allow a sizable maximum account size that aligns with the cost necessary to provide for the qualified education in a state, and is typically more than $300,000. Lastly, assets in 529s are removed from the taxable estate, while assets in insurance products remain in the estate. Insurance products with a cash value does not have a contribution limit, though enough time would have to pass in terms of making regular premium payments to accrue enough to take a distribution and/or loan against

—Tax Benefits on Contributions: Though there is currently not a federal tax deduction for contributions into 529s, residents in over 30 states plus D.C. receive a state tax deduction or credit for contributions into a 529 plan. Insurance products with a cash value do not have any state or federal benefits on contributions.

—Market Risk & Cost: 529 college savings plans allow parents to self-direct their investments among a menu of options, and therefore adjust their level of risk. Insurance products with a cash value such as whole life insurance tend to track providers of guaranteed returns, and tend to cost more to invest in which decreases total return.

—Investment Changes: 529s are granted two investment changes per year. Changes in investments for insurance products with a cash value typically does not apply, as they are set for long-term goals that typically track providers of guaranteed returns.

—Account Control: 529s allow the accountowner to maintain control of the account, and allow for an unlimited number of rollovers if the beneficiary is changed to a member of the family of the previous beneficiary. Therefore, 529s allow changes in beneficiaries while the accountowner maintains control of the account. Insurance products with a cash value allow parents to maintain control of the assets and can be used for any purpose including higher education. Therefore 529s provide resources for a dedicated goal, while insurance products with a cash value can be used for any purpose.

—Financial Aid: 529 assets increase expected family contribution (EFC) by 5.64%, but distributions from 529s do not impact EFC. As with other types of retirement accounts, parental assets in insurance products with a cash value do not impact EFC, though distributions of principal and earnings do increase EFC at the rate of income which is up to 47%. Therefore insurance products with a cash value increases EFC by more than 529s when used to pay for higher education.

—Qualified Expenses at Eligible Institutions: 529 savings plan assets can all be used for any qualified higher education expense such as tuition and fees, supplies and computer technology for the vast majority of colleges and universities in the U.S. and many abroad so long as they are eligible for financial aid from the U.S. Government. Otherwise, the gains portion of the 529 distributions are subject to a 10% penalty and taxes. There are exceptions to the penalty, as covered in a previous issue of the 529 Dash. Insurance products with a cash value can distribute a percentage of the balance tax free that has been accrued over time, and can be used for any purpose including higher education.

—Distribution Restrictions: 529s allow distributions to the school, accountowner or beneficiary. Insurance products with a cash value typically can be used for any purpose including higher education, though only a percentage of the balance that has been accrued over time may be used.

Therefore, advisors, accountants and estate planners should understand the key product features of 529s and insurance products with a cash value to ensure the most appropriate investment vehicle is used to protect their clients against the rise of tuition inflation given the specific goals of your clients.

Next week, we will compare and contrast 529 savings plans and brokerage accounts for college financial planning.