College has become the single largest investment for American families, and for some, the costs associated with funding higher education go beyond the sticker price of tuition. While families increasingly realize the threat of rising college costs, the overlooked scope, and scale of its effects are arguably even more detrimental as parents nationwide sacrifice their own retirement stability to fund their child’s academic pursuits. This is the unfortunate reality of Americans nationwide, but luckily, college planning services are on the rise to mitigate these challenges.
Qualified college planners are vital in today’s environment because of their unique ability to address college funding concerns and the dilemma of selecting the best schools for students and parents. After working with a college planner and selecting the colleges you will apply to, the question, “How do I pay for college without going broke?” inevitably comes into play. Essentially, there are only five ways to pay for college: federal loans, private loans, qualified assets, home equity, and cash flow/nonqualified assets. However, government rules per the FASFA application list out which assets are exempt and ultimately do not raise your Expected Family Contribution (EFC)/Student Aid Index (SAI) scores. These include whole life insurance, annuities, and index universal life insurance (IUL). Compared to whole life insurance and annuities, IUL can have many moving parts, so it is crucial to ensure that your college plan is designed correctly for you and your child.
Unfortunately, there is no perfect, one-size-fits-all solution for all families. Every option has pros and cons and will affect each family differently in the future. For example, some families might need strong guarantees of a whole-life policy in the early years. Others might need a solution for sheltering some extra assets outside the plan, requiring the funds to be fully liquid once the student graduates. Some families might need indexing options that could provide a higher rate of return and help supplement future retirement income.
If you have investigated college funding plans before, you may wonder why a 529 plan has yet to be mentioned. A 529 plan could be a sufficient college funding vehicle for some, but the restrictions of a 529 could prevent many families from receiving financial aid awards. Additionally, a 529 is not a plan. It is an investment product, however, a 529 can still be incorporated into a great college plan design. Nevertheless, every family has unique needs and requires a unique holistic financial plan to pay for college without sacrificing their future retirement income. An IUL could be a strong option for many families. Before purchasing a policy, it is important to understand how it can provide supplemental income in retirement, the fees associated with IUL, and why a properly managed portfolio is not a sufficient alternative for paying for college.
One of the biggest advantages of IUL is the longevity of the funds and the ability to use those funds later in life to supplement retirement income. When comparing a properly designed college IUL to a managed portfolio, the money coming out to cover the tuition and/or loans should be the same as the managed portfolio. The key difference is how long it will last during retirement. Most IULs have different options to access the cash value but, for college planning, an index/variable loan feature is my preference.
The main advantage of using a variable/index loan option is that the money pulled out to cover college expenses is still in the IUL indexing strategies and earning a full rate of return based on indexing performance. This is why when we compare the IUL college plan to a managed portfolio. When designed correctly the IUL will last past age 100 while the managed portfolio runs out of income on average when the client is in their late 60s to early 70s, assuming the same ROR between the IUL and managed portfolio. With this incredible longevity, IUL can be an advantageous source of supplemental retirement income.
While the longevity of the funds is highly beneficial, this benefit within an IUL comes at a small cost in the form of loan fees. It varies from company to company but, on average, it should be around a five to six percent loan fee. The overall fees in an IUL are essentially front loaded, which allows the fees to be pennies on the dollar when the clients are in their retirement years. Most well-managed portfolios have fees from one to two percent which has been the average rate for the past decade.
To compare this cost with a managed portfolio, it is easiest to compare the fees in 10-year segments. The first 10-year segment will be the most expensive because IUL fees are front-loaded, but once you get past the first 10 years the fees start declining. The second 10-year segment is where I see most fees are about the same or slightly less than the comparison managed portfolio. The third 10-year segment and beyond is when on average the fees should be 1/3 to 1/2 the cost compared to the managed portfolio, again, if the IUL was designed correctly.
Although some falsely claim that the IUL expenses will be the highest once the client starts taking their retirement income, the fees within an IUL are less when the clients are in their 60s, 70s, and 80s compared to a managed portfolio that charges one to two percent. When comparing overall dollars spent, the typical cost savings are significant and often total upwards of several thousand dollars. This means more of your money is in the plan earning a rate of return versus wrapped up in fees and ultimately spent. Although the front-loaded fee may seem intimidating, this bigger-picture view of IUL fees demonstrates how efficient this structure can be in the long run.
When comparing the total fees of the IUL with what it could hypothetically earn based on the indexing options, you can locate when your break-even point is. Most correctly designed IULs should have a break-even point between years three and six. Keep in mind that it is impossible and frankly illegal to provide a guaranteed rate of return of what each indexing option will provide. Most carriers will provide lookbacks on what their indexing option would have returned in previous years, but by no means is this a promise or guarantee of how it will perform in the future. Since these plans are designed to start paying off college loans between years three to five, the design itself needs to be more conservative. For example, I prefer to use an ROR of six to seven percent based on the proposed carriers’ fixed rate options.
It is important to note that having a properly managed portfolio is a great thing. I have a couple myself, but they are not beneficial for paying for college. They are not exempt from the financial aid formula, they have no protection against market volatility, most accounts are more expensive, and the money spent on college expenses is gone, which means your money is no longer earning a rate of return to help supplement future retirement income. A professionally managed portfolio is like having another great club in your golf bag. It could be a particularly important part of your overall financial planning and retirement planning success but should never be used to pay for college.
It is no secret that paying for college is not going to get any cheaper, and getting accepted into college is not going to get any easier. However, if you work with the right college planner they will be able to develop a personalized college funding plan which could utilize an annuity, a whole life insurance option, or an IUL. As the higher education landscape transforms, families need to consider alternative solutions. When remodeling a house, people hire professional contractors, plumbers, electricians, and other skilled workers because they know that, if they try to do it themselves, one mistake could have costly consequences. If you would hire a professional electrician to rewire your home so you do not get electrocuted or worse burn your home down, why would you not consider hiring a professional college planner so you do not risk financial catastrophe? If you or someone you know is struggling to find a way to help their child establish their future without risking their own, I encourage you to hire a college planning professional who can help you.
