Variable universal life insurance for college savings?

by Grace

Variable universal life (VUL) insurance as a college savings strategy is usually considered appropriate only for a select minority of  families.  One of its main selling points is that since it is typically not counted in the formula used to determine financial aid eligibility, VUL can be used to “shelter” assets.  However, this advantage only comes into play if a family is on the borderline of qualifying for financial aid, where a few thousand dollars less in assets would nudge them over to eligibility.

VUL basics from the Wall Street Journal

Back in the 1990s, agents started pitching college savers on “variable universal life insurance,” a type of “permanent” insurance that is designed to be in force for the insured person’s lifetime. (That is in contrast to “term” life, a plain-vanilla type of policy that pays out only if the insured dies within a specified period of time.) As with other types of permanent insurance, the buyer’s annual premium is split between the cost of the death benefit, fees to the insurance company and a tax-advantaged savings account.

In the most commonly sold types of permanent life, the money in the savings account is invested mostly in high-quality bonds. Under variable universal life, the buyer has the option to invest in stocks in mutual-fund-like “subaccounts.”

The decision-making process for determining if life insurance makes sense as a college savings tool can be very complicated, so a financial advisor should be consulted if this option is being considered.  Here are some points to consider.

  • You will be paying for life insurance.  Do you need it and could you fulfill this need with a less expensive policy?  If you are insuring the life of your child in order to cut the policy costs, does your child “need” life insurance?  The answer is usually a resounding “no”.
  • If you are trying to shelter money from FAFSA and the insurance value will make a difference in financial aid eligibility, you should ask:  How much aid money be are we talking about?  Will the aid be in the form of a cash grant or loans?  Going through all that trouble for a loan “award” doesn’t make sense.
  • Depending on other factors, a family on the borderline to be eligible for financial aid could likely be one with financial assets valued between $200,000 and $300,000.  This profile does not fit the typical market for a variable life insurance policy, usually designed for more wealthy investors.

Investors should also be careful when considering projected earnings on VUL subaccounts, which are typically illustrated to show a 12%  annual return.  Very few advisors consider that to be a realistic number for financial planning.

Bottom line for variable universal life:

While it has some major advantages, investors should understand the risks.

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