What’s the Best Way for a Parent to Save Money for College for a Child?
(I was reading an article about how the writer (a doctor with no background in finance or investing who writes about investing) was going to save money to send his kids to college and I thought he had a pretty good plan, except for one part. Here is the response I gave him and how he responded. I found it remarkable that he was so unwilling to agree with the most obvious benefits of an IUL, and that his responses showed a willingness to label ALL consultants as scam artists. Not a month goes by that I don’t read about some incompetent or unethical doctor, so I wonder how this guy would feel if I labeled all doctors as incompetents? He calls himself the White Coat Investor and, after he deleted my last response, I added it here.)
I agree with most of what you’ve written, except for the use of the 529 plan. I believe an indexed universal life (IUL) insurance plan would not only provide more money for college from much smaller payments, it would provide a wealth of continuing benefits that would last the lifetime of your child. Yes, I’ve read your articles that bash whole life and I probably agree with 80% of what you’ve written and, yes, I’m a licensed agent that sells IUL’s, so you can discount my opinion by whatever factor you like. IUL’s have many advantages over both whole life insurance and 529 college savings plans and I will try to keep this response as factual as possible.
The numbers give IUL’s a wide advantage. 529′s provide tax benefits up front that go away if the money is used for anything else, and you access the money by withdrawing it, which means nothing is left afterward. You’re done. If you need life insurance, you’ll have to pay premiums for it for 30+ years.
With an IUL purchased and properly set up at birth, or soon after, just $100 a month for 18 years (a total of $21,600) in after-tax payments can provide $10,000 a year for four years of college (tax-free using policy loans that are either interest-free using a standard “wash loan”, or provide a negative interest charge using a variable rate loan that offers the opportunity to earn more on the collateral than is charged for the loan, AKA arbitrage). PLUS, the cash value continues to grow without any additional payments after those first 18 years and can provide another tax-free $50,000 disbursement around age 35, another one of $250,000 around age 55, then annual distributions of over $200,000 per year for life beginning at age 67, all tax-fre. In addition to all this, your kid will never need to buy an outside life insurance policy because the death benefit in this case grows from about $115,000 at issue to over $1.6 million by age 66 and continues to grows until death. Please note that ALL expected expenses have been deducted from these numbers, which came direct from an illustration using software provided by a carrier rated A+.
What’s the catch? There are two. One, for the child to qualify, at least one parent or grandparent must also have an IUL with the issuing company. Two, the indexed growth of the cash value will be tied to the growth in the selected index. Let’s use the S&P 500, which has grown at a real rate (without dividends) of 8.39% over the last 30 years (the average rate of growth is closer to 10%, but includes negative numbers which distort the average). In IUL’s the growth has a guaranteed floor of 0%, and adds interest equal to the rate of growth of the index, if any, up to a cap rate. If the cap rate is 14.5% and the S&P 500 grows 10%, you get 10% added to your cash value. If the growth is 20%, you only get 14.5%. But if the index goes down, you get zero. You can never lose money due to the market. So, if the market performs close to the historic averages, then the numbers I’ve given above are pretty accurate. If the market doesn’t do as well, then neither will the IUL. But if the market in general is doing poorly, how will the investments in your 529, or any other part of the market, be doing? And, yes, the interest percentage is only applied to the cash value after expenses, but isn’t that also the case of most securities investments?
One interesting things about IUL’s is that the expenses become a lower % of the cash value over time as the cash value grows. That’s not the case with money in a 529 or 401k. If a 401k has gross expenses of just 1% and a balance of $100k, then the expenses are $1,000. But the same percentage applied to a balance of $400k is $4,000. Say what you will about whole life, the expense rate in an IUL, as a percentage of the cash value, goes DOWN over time.
How can a baby IUL do all this? One, because the cost of insurance for an infant is so small that almost all of the premium goes toward the cash value, leading to a fast buildup of the cash value. Two, because of the time element. Having this money working throughout a child’s lifetime leads to massive growth over time.
He answered my post with this -
I disagree that using a permanent life insurance policy to pay for college is a good idea. I doubt I’ll convince you. But I want to make sure WCI readers don’t get the impression that I think this is a good idea.
While investing “just $100 a month” for 18 years to get a benefit of $40,000 sounds awesome, if you run the numbers (and bear in mind these are your projected numbers, not the guaranteed numbers which I’m confident are far lower) it reflects a rate of return of about 6.4% per year. I mean, I guess that’s exciting to people who sell insurance for a living, but it’s not very exciting to someone whose daughter’s 529 has had an IRR for the last 8 years of about 9% a year (yes, that includes the 2008 meltdown.) I’m not saying there’s no value in the IUL after you use it to pay for college, but that’s a pretty steep price to pay for that value. If I invested $100 a month at 9% for 18 years, I could have $13K per year for school and not have to worry about taxes, interest, taking loans, or worrying an insurance agent may be taking advantage of me. Seems like an attractive trade off for me.
With an IUL you might not lose money due to the market, but you can (and will, at least in the first few years) lose money due to the insurance, the company providing it, and the agent selling it. I’ve discussed all this elsewhere in my posts on IUL.
I’m not sure why you think 1% expenses in a 401(k) is a low figure. I view it as a very high figure. Expenses on a low-cost 529, IRA, 401(k) etc are ridiculously small compared to those in any insurance policy and have a very long way to rise before ever becoming close. I’m sure you’re very talented at selling these policies as a college savings tool though. A lot of people wouldn’t see through the arguments you’re making. However, I’ve addressed this all in my series on Myths of Whole Life Insurance previously. The only advantage of an IUL over WL is that you have the possibility of a higher IRR if the market does well (and of course, the possibility of a lower one if the market does poorly.)
You want to use it for your own college savings? Knock yourself out. It’s a free country. There are many roads to Dublin. But I think it’s a lousy idea that is used primarily by insurance agents to sell more insurance.
I responded with this -
Life Insurance Agent, Santa Clarita, CA