Originally created 07/25/99

College savings plan has some drawbacks

DALLAS -- Can taking out an insurance policy help the average family save for college? Don't bet your (variable) life on it.

More and more, variable life insurance is touted as a great new vehicle to help meet college costs -- it's a savings tool, includes tax-deferred investment options and allows for tax-free loans.

But it's not for everyone. It can be pricey, has limited tax benefits for low- or average-income families and helps only those with young children. Besides, many financial advisers say there are other ways to save for college.

"Recommending variable life to the masses of people is a wrong thing to do," said Raymond D. Loewe, president of College Money, a Marlton, N.J., firm that specializes in college planning. "If you're in a high tax bracket, though, it's a magnificent tool."

Mr. Loewe brought up the use of variable universal life for financing college during the July annual convention of the Institute of Certified Financial Planners in Dallas. A few financial advisers attending a session he ran on crisis college planning said they saw the use of variable life as a growing trend among clients who don't qualify for financial aid because their incomes are too high.

"It's certainly on the upswing," said David D. Hollands, a certified financial planner from Plano, Texas, who recommends it to certain clients above the 28 percent tax bracket. "This is for people who have no real expectations of getting financial aid."

With a variable life contract, you get the same guaranteed death benefit as with whole life, except the policy's cash value can be invested in tax-deferred stock, bond or money market portfolios. Policyholders can shift investments from one portfolio to another tax-free, and they pay a fixed annual premium just as they would with whole life.

Life-insurance cash value isn't used when calculating college aid, which is a plus for all college planning regardless of income.

But perhaps the biggest advantage of variable life, according to Mr. Loewe, is that you can borrow on the cash value, generally at low rates of interest and without being taxed.

So, when a tuition payment comes due, you can take money out of the policy without being socked with taxes. Of course, you lessen the payout upon death. For instance, if you borrowed $20,000 on a $100,000 policy, you'd have $80,000 left.

But as Mr. Loewe noted, policyholders are aware of that and are buying variable life mainly for college savings.

Still, there are drawbacks to using variable life for college planning.

For one thing, policies can be expensive. Premiums can be high, depending on how the contract is fashioned, and the policies often are loaded with hefty sales commissions and management fees that can erode earnings.

Most variable life policies have penalties if policyholders withdraw money during the first 10 years, which is why financial advisers recommend against families with older children using them.

"If your children are under 8, that's the optimum age," said Mr. Hollands.

Errold F. Moody, a financial planner from San Leandro, Calif., who runs a consumer Internet site (www.efmoody.com), says no one should use them for college planning.

"It's life insurance you're buying. If you don't need life insurance, don't buy the stuff," he said.

Mr. Moody said most individuals who need life insurance should purchase a term life policy -- which has no saving or investment feature, just a payout upon death -- and invest the rest on their own.

He prefers index funds for families with young children, such as ones modeled on Standard & Poor's 500-stock index. Index funds in the big-stock sector of the market consistently have achieved better results than most managed funds in recent years.

All the gains, when gifted to the child later on, will be taxed on long-term capital rates, he said.

He suggested other tax-sheltered options: an Education Individual Retirement Account, where the proceeds aren't taxed, though contributions are limited to $500 per child per year; a regular IRA, which allows for distributions for college tuition; and the Hope Scholarship credit, a $1,500 credit available for tuition and fees for the first two years of college.

Mr. Moody said variable life primarily is advantageous for insurance agents who stand to reap high commissions.

"They could put their kids through school," he said.


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