Hey radicals, welcome to the show. This is Radical Personal Finance, the show dedicated to providing you with the knowledge, skills, insight, and encouragement you need to live a rich and meaningful life now while building a plan for financial freedom in 10 years or less. Broadcasting to you today from a very rainy afternoon here in West Palm Beach, Florida at the Radical Personal Finance HQ.

And the question of the day comes in from Alan. Alan writes in and says, "Joshua, what are your thoughts on using whole life insurance as a college savings plan? If you don't like it, why? If you have an episode about this already, let me know which episode number." Alan, thanks for writing in with the question.

I do not have a separate standalone episode on the topic of using whole life insurance to save for college. But I do have some thoughts on the subject. Now, quick preamble on the topic of whole life insurance. I am not a partisan on this issue. I'm not an extremist.

I don't go for the perspective that you should never own or purchase whole life insurance, nor do I go from the perspective that whole life insurance is the latest, greatest thing and you should put all of your money from your checking account, savings account, and withdraw every single investment into a life insurance plan.

I don't buy either of those scenarios myself. I look at it in a little bit more of a balanced way and say that whole life insurance is a financial product. It has certain fundamental attributes, certain fundamental unique characteristics, and those characteristics are what you weigh and consider to decide what and how you should use the product.

For any new listeners of Radical Personal Finance, I do not hold a life insurance license. I used to have life insurance licenses. I used to be a licensed financial advisor, but I am not licensed to sell life insurance. I do not have any financial relationships with insurance companies. So my financial conflicts of interest in this area are nonexistent.

I own whole life insurance policies on me. My wife has a whole life insurance policy and I own a whole life insurance policy on each of my children. However, I do not, would not, and don't recommend the use of a whole life insurance policy as a college funding plan.

Long time listeners of the show will know that in general I'm opposed to the extreme prioritization of college saving. If you have not yet heard it, you should listen to episode 276 of Radical Personal Finance, which is titled "Why This Financial Planner Refuses to Save Money for His Kid's College." This financial planner refers to me, Joshua Sheets, and I refuse to save money for my children's college.

That's not because I'm an irresponsible parent, but because I believe that this is a really silly thing to do with money when there are many other opportunities and alternatives. For the sake of this conversation, obviously, I'm going to skip past that opinion and answer your question directly, assuming that you are desiring to save money for your child's college.

Whole life insurance should not be the first thing that you consider to save for whole life insurance. Also, check the Radical Personal Finance archives. I've done extensive shows on 529 plans. I've done extensive shows on the Coverdell Educational Savings Account. Both of those are superior mechanisms for you to save for your child's education.

The Coverdell Educational Savings Account and the 529 plans have better tax advantages for you with regard to then life insurance. You can accumulate the money in those accounts, and as long as you use it for college, you can distribute the money out of them completely tax-free without ever paying tax on the gain.

That is superior to life insurance. In addition, you can invest in assets that have a higher potential for growth, whether that means choosing a selection of stocks and equities, which if you have a long enough time horizon, will hopefully appreciate at a higher rate than a life insurance policy will.

Most life insurance policies, whole life insurance policies, are going to be based upon the life insurance company's general portfolio, their general account, and the majority of that portfolio is going to be invested in fixed income, very stable and secure assets. So in general, if you own stocks in a 529 plan and if the stock market appreciated in a healthy manner, you would usually wind up with more money in that type of account than you would in a life insurance policy.

If you have other potential opportunities for investments, let's say that you invest in some unique approach, you buy tax liens or a local real estate investor, etc., you should look into using a self-directed Coverdell educational savings account. If you accumulate money in a self-directed Coverdell educational savings account, you could possibly be able to control your own investments and use the money there from a Coverdell either to cover primary school expenses or to cover college expenses as well.

So all of those are better options. But of course, for the sake of this podcast, we want to talk about life insurance as a college funding mechanism and talk about what's great about it and what's not great about it. I said a moment ago that I don't generally recommend and I don't recommend that you start with using a life insurance policy for college savings.

But I also see many ways that you can use it for college. Let me give you a couple of ideas. First, the way that most people think about approaching this I don't think works. The way that most people think about this is, "Hey, I've got a new child, a young boy, young girl.

I want to buy a life insurance policy on their life so they are the insured, the parent would be the owner of the contract. I'm going to buy this policy on the life of my son or daughter. This policy will accumulate cash values within it and those cash values will be available at the age of 18 to pay for college expenses." I don't think that plan works.

In the years that I worked as an insurance agent selling life insurance, I had many people ask me about this and I worked and worked and worked on different plans to try to see if there was any way that I could get the policy to work for that purpose.

I just couldn't make it happen. The reasons are primarily due to the limitations of using a life insurance contract as this vehicle. The first problem with using a life insurance contract as this vehicle is its life insurance. When you're using a cash value policy, a whole life policy, you have to pay for an insurance contract that's going to be enforced for a very long time.

You have to pay for the death benefit. With children, it seems like the ratio of expenses is very high. Usually you're buying generally pretty small policies. You can't buy a $5 million insurance policy on your child unless you have a $50 million policy on you and that's just not the world that most of us are living in.

It always seems like the ratio of the cost of insurance is very, very high on those policies. Not actuarially, just simply in the short term. The big problem with life insurance contracts when they're measured on the spectrum of is this a good use of money as for an investment, for cash accumulation, is all the expenses come out up front.

In general, whole life insurance policies accumulate cash very slowly in the beginning years. The reasons for that are numerous. First, there is a heavy expense in the first year of a life insurance contract to pay the commission to the life insurance agent who sells the policy. That commission rate is generally at least 50% and it can range to as high as 100% depending on the company and depending on the contract.

That's a heavy chunk of cost and all of that cost comes right out of the policy. The company themselves are paying that commission to the agent. Well, there's no free money. The insurance company isn't printing money to pay the commission from some other account. That's coming out of the policy.

You have a heavy commission up front in a whole life insurance contract. You also have significant expenses that the insurance company charges to the contract in the beginning years. Obviously, there's the big one which is mortality and expense. The mortality and expense charge just simply reflects the cost of the insurance.

When you buy an insurance policy, the insurance company is on the hook from day one to take that money and to pay a death claim if you die or if the child dies in this case. Given this commitment, they have to set aside a significant amount of money up front to start to accumulate to pay that death benefit.

They pull out those mortality and expense charges in the beginning. Now, of course, there are other expenses. These are not necessarily directly reflected in the policy, but there are underwriting expenses. There are medical expenses and the insurance company has to pay for those in the early years as well.

Whole life insurance policies in the first year generally accumulate almost no cash value. The purchase of a whole life insurance policy is one of the worst things that you can do if you keep the policy for a very short time. It will be extremely expensive. You never purchase a policy that you're only planning to keep for a short time.

The only place that whole life insurance will be useful to you is for the accumulation of money that's going to be for a very long time. The minimum amount of time is probably at least 15 to 20 years. That's the fundamental problem with using life insurance contracts for saving for a child's college.

When you actually run the numbers, run the proposals, you're going to have heavy expenses in the early years and it takes them a long time to build up and accumulate cash. There are some policies. I've talked to college planning experts, some of whom are also life insurance agents, and they use specially designed policies that are partly designed for this purpose.

I've never been convinced. I've never seen the proposal. If any of you work in that business, I would ask you to send me some proposals. Run them for some sample children and let me look at the numbers. Let me look at the ledgers and understand. I've never in my career found one that worked, that I looked at it and said it was a good use of the dollar.

I never sold a client a whole life insurance policy on his or her child with the goal of using that policy to pay for college. One final point on why and then we'll move on to how you can use life insurance to pay for college. The other major thing to recognize is why are you doing all this?

Why are you buying a cash value policy? You say, "Well, I'm buying it for the investment component." Okay. If that's the case, you're going to be accumulating money in the contract in a very safe manner. You basically own what's equivalent to a fixed income portfolio. It's going to be very, very steady growth.

That's going to save some of the volatility. But the other thing that people talk about is with regard to the tax benefits. The problem with these contracts is they don't accumulate many gains and because they don't accumulate many gains, you don't actually save that much on taxes. So the tax benefits are negligible.

Finally, what about the benefit of the – the much vaunted benefit that money that's accumulated as cash value in a life insurance policy is not reported on the FAFSA, the Free Application for Federal Student Aid? This is true. The FAFSA doesn't consider cash value life insurance as an asset.

But this can be misleading for a couple of reasons. Number one, that's not the only asset that is not considered on the FAFSA. For example, what about money that's accumulated in a qualified retirement account? That can be done. That money is not reported on a FAFSA. Let me read to you directly from the FAFSA and show you how certain assets are treated and how certain assets are not treated.

So I'm reading here from the notes instructions from the FAFSA, the Free Application for Federal Student Aid, from their instructions here. These instructions would be – are the same notes where the student is reporting their income and their assets and also for the parent. When the parent is listing – when the parent or student is listing the net worth, here are the definitions.

Net worth means the current value as of today of investments, businesses, and/or investment farms minus debts related to those same investments, businesses, and/or investment farms. In calculating net worth, use zero for investments or properties with a negative value. Investments include real estate. Do not include the home in which you live.

Rental property includes a unit within a family home that has its own entrance, kitchen, and bath rented to someone other than a family member. Trust funds, UGMA and UTMA accounts, money market funds, mutual funds, certificates of deposit, stocks, stock options, bonds, other securities, installment and land sale contracts including mortgages held, commodities, etc.

Investments also include qualified educational benefits or education savings accounts. Example Coverdell savings accounts, 529 college savings plans, and the refund value of 529 prepaid tuition plans. For a student who does not report parental information, the accounts owned by the student and/or the student's spouse are reported as student investments in Question 42.

For students who must report parental information, the accounts are reported as parental investments in Question 91, including all accounts owned by the student and all accounts owned by the parents for any member of the household. Money received or paid on your behalf also includes distributions to you, the student beneficiary, from a 529 plan that is owned by someone other than you or your parents, such as your grandparents, aunts, uncles, and non-custodial parents.

You must include these distribution amounts in Question 45J. Now let's get to the big ones here. Investments do not include, so everything before was things that are included, investments do not include the home you live in, the value of life insurance, retirement plans, 401(k) plans, pension funds, annuities, non-education IRAs, Keogh plans, etc.

or cash savings and checking accounts already reported in Questions 41 and 90. Investments also do not include UGMA and UTMA accounts for which you are the custodian but not the owner. Investment value means the current balance or market value of these investments as of today. Investment debt means only those debts that are related to the investments.

Business and/or investment farm value includes the market value of land, buildings, machinery, equipment, inventory, etc. Business value does not include the value of a small business if your family owns and controls more than 50% of the business and the business has 100 or fewer full-time or full-time equivalent employees.

Business value does not include the value of a small business if your family owns and controls more than 50% of the business and the business has 100 or fewer full-time or full-time equivalent employees. For small business value, your family includes 1) persons directly related to you such as a parent, sister, or cousin and/or 2) persons who are or were related to you by marriage such as a spouse, step-parent, or sister-in-law.

Investment farm value does not include the value of a family farm that you, your spouse, and/or your parents live on and operate. I read these things to you to demonstrate to you that often there are many ways that you can have assets that are not reported on the FAFSA.

So yes, life insurance is one of those assets and you should consider that when potentially owning a life insurance policy. However, you can also do the same thing with say an IRA or Roth IRA. You can do the same thing with a Roth IRA for you. You can do the same thing with a Roth IRA for your child.

You can also pursue strategies such as paying off your mortgage before you, if you have a bunch of money sitting in investment accounts or in checking or savings accounts and you need to apply for the FAFSA, then consider wiping out your mortgage debt and putting all that money into home equity because the home equity in your principal residence will not be reported on the FAFSA or possibly owning your own business, small business.

So you need to read these, read documents for yourself is my point. Hard to do, easy to say, hard to do, but it's important. So in short, these are the reasons why I don't think it's a good plan to pursue the purchase of a life insurance policy for your children as a primary means of funding college.

I think there are better ways. I think there are more efficient ways. College funding accounts are superior. I think that there are other ways with – again, IRA is even superior, Roth IRA, make distributions at college age to cover that. So all of these ways are superior. There are other things that you can do and when you actually look at a life insurance contract and see the problems with it, the costs are up front, the investment return is generally low over the short term like that, the tax savings are negligible because the investment return is so low and the life insurance policy breaks down.

That does not mean I don't recommend you consider purchasing a whole life insurance contract for your child. I own them for my children. Does it make it right? Does it mean your situation is the same as mine? Does it mean you value the same things that I value? Just simply saying I'm not opposed to your purchasing whole life insurance contracts for your children.

I'm opposed to your purchasing whole life insurance contract for your children as a primary means of paying for college or where the primary motivation is not the benefit of owning the life insurance contract, having the death benefit in place, the benefit of having and protecting your child's ability to buy insurance in the future or the benefit of having some cash value accumulation over the long term but that will be after college.

Just opposed to using it as a primary vehicle for college funding. Now how could you use life insurance in an effective and efficient way to pay for college? Notice that all of the previous conversation was reflective of a life insurance contract where your child is the insured. What if your child is not the insured?

Well, if your child is not the insured, that opens up many more options and many more opportunities. Let's pretend for a moment that you don't have children yet. Just go with an ideal scenario. Could you purchase a large whole life insurance policy that will accumulate cash value effectively over the next 15 to 20 to 25 years with the intention of keeping it in force for much longer than that?

You absolutely could and that's one of the ways that life insurance contracts can be used. Because it's not tied to the life of your child, you would be able to buy a larger contract to be able to get more money into it where the savings were more meaningful. Because the policy were flexible, you wouldn't have to use it for college if you found other opportunities, other alternatives.

Now what if you bought such a contract and you scheduled it to make sure that during the time that your child is in college, you wouldn't have to make premium payments if you didn't want to? This is my favorite plan. This is what I did a couple of times as an insurance agent.

As long-time listeners of the show will know, I'm pretty good at talking people out of saving in college savings accounts. If it's important to you, great, but I'm pretty good at talking people out of it, simply recognizing that that shouldn't be the first place to focus. Wealthy parents pay for college for their children.

So let's focus on being wealthy and let's make sure that we're flexible during that time we're paying for college. Because the college situation is so unknown, we don't know what the FAFSA is going to be in 15 years. We don't know who the president is going to be. We don't know if college is going to be free.

I personally, now who knows, my politics, my political crystal ball is often wrong, but I see very good indication to say that there will be many options to go to college without paying out of pocket for it in 15 years, 10 to 15 years. Today, any student who is academically capable and wants to can earn enough money working part-time at a fast food restaurant to pay and get an accredited degree from a low cost online university or distance learning or local community college.

It's not hard to pay for college. So I like the parent to have flexibility. So what I have often done, if the parent has the desire or the need or the desire to own life insurance, if it fills some of those financial goals, their financial needs, the primary one being, "Hey, I want to have a whole life insurance contract that stays in force forever.

I'm well insured for the temporary needs. Temporary life insurance needs should always be covered with term life insurance, but I'd like to have some insurance that lasts forever." That's a really good start to fit to say, "Oh, life insurance is an appropriate fit." I'd like to have some money accumulating within a life insurance contract.

I like to keep some of my portfolio in a place that is safe where it's steady growth. I know that I'm giving up a significant amount of potential upside in terms of my total return, but I like to have some money that's safe and steady. It makes me feel good that it's protected from annual taxation.

It's growing tax deferred. Yes, I may or may not pay taxes on it when I take it out, but it's growing tax deferred for now. I like the flexibility of it. If the client, notice that was pretty elegant sales language there, and that wasn't as elegant as I could make it, but if the prospective client or prospective purchaser of a life insurance contract is using phrases like that or is agreeing to phrases like that, now we have a good fit for life insurance.

How do we design it so that they can use the policy for college? My first goal is that they not use the policy for college. My goal is that they just pay for college. What I would do in a financial planning situation is I would work very hard to make sure that if a parent knows the years that their child is likely to be in college in advance, they work hard to lower their expenses during those years.

That means get on track to have a mortgage paid off during those college years if possible. It's very reasonable that many parents in the younger years, whether children are young and they're starting to think about buying college accounts, because after all, that's the scenario we're in here of buying a life insurance contract at an early age.

This doesn't work if you're looking at a 10-year-old. It doesn't work at all, but it certainly doesn't work with a 10-year-old. It works the best for a one-month-old, and even there it doesn't work. It just doesn't work to buy the contract the way that most people think about. But can you have a house paid off by the time your child is 18 years old?

Many people, if not most, who think ahead and plan can be in a situation where they have their house paid off when their child is 18 years old and heading off to college. If you don't have a personal mortgage payment to make every month, can you afford to make payments to a university?

The answer is yes. But let's go a little farther than that. Can you make sure that your cars are paid off during that time period? Very few people think strategically about their needs for transportation. They don't time it. They sign up for a loan and they don't know how long it's going to last, and they just don't think about it.

Think about it. Make sure that you don't wind up making car payments during the years in which your child is in college. Let's say your mortgage payment was $1,000. Now let's take away a $400 car payment. We're at $1,400. $1,400 a month buys you a lot of tuition, and you can do it without stress.

The tax savings of saving for college, because it's so short term, are negligible. I'd rather you just pay out of cash flow in general. Now if you've saved diligently in retirement accounts, can you also have those assets not be listed on your FAFSA so that they're not counted against your child's financial aid opportunities?

Yes. If you've saved in something like a Roth IRA, you can take out your contributions and use that money without paying any income tax because we're just distributing contributions. You can use that money to pay for college if you desire, and you can leave your earnings inside the Roth IRA to grow tax-free.

In addition, if you've saved diligently into your retirement accounts all along the way, can you stop making contributions or at least not make contributions beyond the employer match during the years that your child is in college? The answer is yes, you can. I believe that in general, that option would pay off much more than buying a life insurance policy on your child's life.

Better approach. Then finally, what about life insurance? You thought I forgot, didn't you? What about life insurance? Buy a life insurance contract that has no premiums due during the years your child is in college so that you can do exactly the same thing. If you're going to buy a whole life policy, schedule it to quick pay in about 15 years if you have a child who's younger so that you can drop that off.

Even if your policy is not scheduled to quick pay, quick pay meaning you either stop contributing to the contract or just have the dividends pay the premiums for you, start taking your dividends and apply your dividends to the premium. There you can free up a few hundred dollars. I'd much rather somebody have a life insurance contract and with let's say that at that point in time their premiums are $500 a month, but at that point they've got the equivalent of $350 a month of dividends.

Let's just apply those dividends to the premium payment. They pay out of pocket $150 and the other $350 a month gets freed up to be used for tuition payments. If your child winds up going to an elite Ivy League school and you've accumulated money in all of those scenarios and you need to take money out of the life insurance policy, if you've got a big policy for you or a big policy for your wife, that's a really good way to do it.

Just take out a loan on your big policy, use that to pay the tuition payments and then pay the loan back on your life insurance contract over a short period of time. That's the most efficient way to do it. Because you're taking the money out of your life insurance contract in the form of a loan, there's no income reported.

Because there's no income reported, there's no income reported on the FAFSA. You continue to be in good shape where your FAFSA is well set up and you've accumulated money in a very efficient way. Hope that's helpful. Hope that's clear. In summary, the question is this, what are your thoughts on using whole life insurance as a college savings plan?

If you don't like it, why? Direct summary or answer to that question, summary of the show is this. I don't think life insurance contracts on the life of your children work well for college savings because I've never seen one that accumulated enough money where it was worth the hassle.

This is due to the fundamental characteristics of whole life insurance where the costs are up front, the investment return tends to be lower than other opportunities because it's a fixed income portfolio, and the tax savings are generally negligible because of the low investment return and because of the short period of time for the money to grow.

So I don't recommend that you use that as a primary way of paying for college. There are more efficient ways. I do recommend that you can consider using a whole life insurance contract on yourself or on your spouse, and that can be a backup plan for college. But my favorite way to pay for college is just simply for you not to save for college, but for you to plan to pay out of pocket for college when that time arrives.

That in my opinion is the very best way to do it. Don't forget about all the other fundamentals, shop for college aggressively, apply for student loans aggressively, et cetera. But I think that's the best way to use life insurance to plan for college. That's it for my show today.

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