Impersonal Finance

One thing I should mention is that I am not against 529s per se. Actually, I like them a lot for grandparents, rich uncles, generous family friends and the like. If these people actually think to contribute to your child’s education, by all means let them. It probably means they have the disposable income to do so and I would absolutely not turn them down.

That being said, the point of this article is:

How Best to Fund Your Child’s Education

If you’ve gotten this far, you are at least curious as to where this is going. The fact is that very few people can afford what college will likely cost in the next 10-15 years. I’ve seen a fairly consistent number of 8% inflation on education costs. When I ran a college funding scenario for a friend of mine, we came up with $600,000 as how much a four year education at a top notch institution would cost in 15 years. Look at your own life. How many people do you know who can sock away enough money to have that much money in the next 15 years? One person? Maybe two? The point is that how we fund it and what vehicles we use is infinitely more important than the dollar amount being invested.

There is only one solution in my opinion. That one solution is…Wait for it…

Life Insurance

It seriously bothers me how little value some “experts” give to the amazing uses of cash value life insurance. They think it’s the boogeyman of financial planning almost universally refuse to consider it under almost any circumstance. Here is the rub. Please tell me what is wrong with a product where you can pour unlimited amount of funds in to, will grow tax deferred, and upon need, the money (both the principal and growth) may be accessed tax free. Oh, it also doesn’t matter how much you make since everyone is eligible. The Roth IRA? Nope, there is a hard limit and eligibility requirement and it can only be accessed upon reaching the age of 59 1/2. Brokerage account? I don’t think so! Where is the tax deferral? What about capital gains? Savings account? Same problem as brokerage. Taxes are due on the interest.

This is definitely “outside the box” stuff, so digest this. Really think about it before you thumb your noses. The main objection I hear most is the expense. It comes in different forms: it’s too expensive, there are too many expenses, expenses are too high, buy term and invest the difference, etc.

I don’t get it. Why are people so afraid of expenses? My old boss loved using an analogy of a candy bar. When you buy a candy bar, you also get a wrapper. Part of the money you pay goes towards the making of the wrapper. You don’t care what the wrapper looks like. You just want the candy bar inside. This is exactly the same thing. You want the tax deferral. You want the tax free growth. You want the flexibility to do use the money towards education, since that’s the ultimate goal, but at the same time to use the money elsewhere should education funding not be necessary. Life insurance is the only vehicle available that gives you everything you could possibly want in a plan, with the small price being added expenses in the form of “cost of insurance” charges.

It doesn’t really matter what time of life insurance you choose to use. I will detail the various permanent life insurance options in the next post or two, but the basic choice is conservative growth (whole life or universal life) or aggressive, market based growth (variable). I am a believer in being more aggressive the less time you have to fund education and more conservative if you’re starting at a young age. Either way is fine, so long as you are willing to keep funding the program. I guess that is the one other negative. You have to fund the policy on a regular basis, whether that’s once a month or once a year. A 529 or brokerage account can be funded at your leisure and on your time frame.

As I wrap this up, I wanted to illustrate one example and show the dual use that exists in the product. I will use a one year old boy as our insured for a conservative whole life policy. If the parents deposit $500 per month for ten years, they will have deposited $60,000 by the age of 11. The policy at this point will be completely paid up. The child will never have to put in another dime. At the age of 18, there will be $100,000 in the child’s account. If your child must wait until he’s 55 to touch the money, that $60,000 investment will yield over $1,000,000 dollars tax free. If he waits even longer, say age 65, how does $1,800,000 sound?

I will dig deep in to the “buy term and invest the difference” fallacy at a later date, but I want to mention something about it here. First, you can’t buy term on a one year old. But, if we wrote the same ten year pay policy on a 30 year old parent and assumed a pre-tax portfolio growth of 7%, buying term and investing difference would do well in the early years, but just about the time the 30 year old is retiring, the investing the difference would get creamed. At age 73, the whole life policy would outperform the other strategy by over $100,000. It also assumes that you will invest the difference each month which is a huge assumption.

To quote Eric Cartman, “No…no, God no!”

What if I told you that every dollar you put in to your 401(k) would still be yours, but you could only access it if you moved to Florida or California? How many of you would still invest in such a plan?

Since no one would enter in to such a plan, I really can not comprehend the fascination people have with 529s and Coverdell IRAs. So, rather than start with any premise at all, let us start from the beginning. To do this well, I will break up the discussion in to two posts: whether to fund education or not and if so, how best to do it.

To fund or not fund a child’s education

What is more likely, that your child can get a scholarship of some kind or that the government will subsidize the retirement of your dreams? It amazes me how often people undervalue how much money they will need in retirement to maintain their current lifestyle. Since this is not a retirement tutorial, let us just assume that you will need a lot of money in retirement. Some people, even maxing out a 401(k) and Roth IRA, may come up short in what they will need to maintain the same standard of living in retirement as they did when they working. We can also assume that most people are not maxing out both vehicles.

Obviously, it is more likely that a child will get scholarships either need or academic based. There are literally 100s of scholarships available and often the money goes unclaimed. The money is there; it just needs to be found. On the other hand, you only get a small window of time to accumulate assets to retire. Once that window is closed, you better have enough or your lifestyle will be changing drastically.

The bottom line is that there are ways to fund a child’s education with dual use options. The idea being that if the money is needed for your retirement, you can access it for that and if it’s not, you have some great tools set up to help with the educational needs of your children. Either way, there is no need to use these governmental programs when other (and better) scenarios exist.

Stay tuned for Part II and “How Best to Fund Your Child’s Education”.