Education Savings: Part 2 --> Cash Value Insurance Policy

As mentioned in my previous post, there are several ways to save for your child's education costs. In the last post we discussed RESPs and all of the pros/cons as well as most of the aspects of RESPs and how it works. In this post we will discuss how you can use an Insurance Policy (specifically Universal Life) as a way to fund your childs post-secondary costs. (Also referred to as a 'Juvenile Life Insurance Policy'). You can use the below strategy similarly with a Whole Life Policy as well.



In one of my original posts titled "Life Protection" (http://financialhealthblog.blogspot.com/2009/05/life-protection.html), I went through the UL strategy and listed all the different aspects, as well as all the pros and cons of using this strategy. Also, as I mentioned in that post, it is a great way to save and grow money tax-sheltered, and is often used as more of a 'investment' strategy rather then just an 'insurance' strategy.



How does it work?

Essentially it is just a regular Universal Life (permanent insurance) plan that is started in the childs name. The reason it is started in the child's name and not the parents name is because the cost of insurance would be much lower for the child then the parent. That means for the amount of premium that would be contributed, a larger portion of that would go towards the investment component of the policy. At the same time, that child would have and existing life insurance policy that could quite possibly stay with them for the rest of their life.

At the time the child enters post secondary, at age 18 for example, there would have been up to 18 years of tax-sheltered growth that can be accessed.

How to access funds:

1. The funds can be directly withdrawn from the cash value of the policy. The growth of the funds would be taxed in the hands of the child at his/her marginal tax rate, which in most cases would be low or 0. However, if the entire cash value is redeemed, and there is no more contribution to the policy, the policy would inevitably lapse (be terminated).

2. Instead of withdrawing the funds directly from the cash value, you can use the cash value as 'collateral' for getting a loan from the bank. The actual amount of the loan would be less then the cash value and the rate at which the funds are borrowed can be fairly low. Also, the interest can be capitalized -- meaning instead of paying it directly from the pocket, it will be paid out through the policy. This can be a beneficial strategy, since instead of depleting the cash value, that would continue to grow and there would be no direct payment out of the pocket.

Pros/Cons of this strategy

Pros:

- the funds grow tax-sheltered within the policy
- if the funds are withdrawn from the cash value directly, the tax rate would most likely be low or 0
- the child will have an insurance policy which would likely last them their lifetime
- the way the funds are invested can be chosen
- lifetime contribution limit would likely be higher then then that of an RESP
- if the child does not pursue post-secondary education, there is no penalty or setbacks
- funds within the policy can be used for any purpose, not only for education

Cons:

- there is no government grant or contribution
- there is usually an annual maximum that can be contributed
- there is no guarantee of investment performance
- might not be enough funds in portfolio to cover all educational costs

This strategy can be a beneficial strategy in more then one way, and would also give the child a headstart on insurance protection for when he/she is older. However, as any other strategy, it must be used wisely and funded properly for it to work efficiently. This would be a great strategy to use in unison with another form of planning.

Example:

Contributing $2500 into an RESP per year - this would give an annual grant of the maximum of $500 from the government. Any excess funds can be put into a UL strategy, which would start the child off with insurance from a young age, or the excess funds can be put into another form of investment, such as a non-registered (which will be discussed in the next post).

Before using this strategy, make sure to ask your advisor all questions that you feel need to be asked and know all the ins and outs of the product that your advisor is recommending (most insurance companies have similar products but might have minor differences in some aspects). This strategy is not for everybody and might not make sense in all situations, so consult your advisor before taking this route.

I hope you have picked up some good pointers from this post, and as always, please do not hesitate to contact me with any questions or comments.