A friend of mine who recently became a first-time grandparent called me the other day seeking my advice. My friend wants to set up a college fund for his new grandson and he was all set to do a 529 Plan, and then his daughter told him that she didn’t think that was a good idea. She evidently had gone to a seminar for new parents and she was told that there are some downsides to the 529 Plan when it comes to grandparents, and that there were better options to consider. I asked my friend what better option did she recommend, and he said the person at the seminar recommended that as opposed to a 529 Plan, a life insurance policy would be a much better option. Of course, that was not a surprise to me considering that the seminar was put on by an insurance agent. That being said, there is a lot of mis and disinformation when it comes to 529 Plans, particularly, when it comes down to grandparents.

I believe 529 Plans such as the Michigan Education Savings Plan are wonderful ways to save for a grandchild’s college education. A 529 Plan offers the advantage of having money grow tax free and then be used at any time for college costs. You can make the argument that for the great majority of people, when a life insurance policy pays the death claim that it is also tax free. However, let’s not forget the key point, and that is you have to die to collect. As I said to my friend, what happens if he is still living when his grandchild goes to college? The money won’t be available to use. Of course, you can take a loan on your insurance policy; however, not only do you have to pay interest on that money, but the amount that you will be able to withdraw is going to be minimal. With a 529 Plan, you have much greater flexibility as to how you can withdraw the money. In fact, there are even provisions in the new tax law that will allow you to use money in a 529 plan to pay for a grandchild’s kindergarten to 12th grade education.

The daughter was also told at the seminar that when grandparents set up a 529 Plan, it could hinder the child’s ability for financial aid. Once again, this is not accurate. When a grandparent establishes a 529 Plan it does not impact, whatsoever, the child’s ability to obtain financial aid. There are, however, issues that could impact a child’s financial aid, but those deal with how and when money is withdrawn from the 529 Plan. Basically, the way the rules currently are, when money is withdrawn from a grandparent’s 529 Plan for a grandchild’s college education, that money is treated as untaxed income to the student. As a result, it is potentially possible that their financial aid package can be reduced. However, there are a number of ways to handle this so the grandchild is not adversely affected. In addition, as I told my friend, who knows what the rules will be 18 years down the road when he potentially would use the money for his grandchild. Just like we’ve seen all sorts of changes on 529 plans over the last number of years, we will continue to see changes into the future. I should also mention that if a child does inherit money from a grandparent’s insurance policy, that money would be treated as a child’s asset and thus, would also adversely affect their ability to obtain financial aid. In fact, it would potentially count more against them than with the 529 situation.

We should also not forget that the 529 Plan has certain advantages for the grandparent. For example, if for whatever reason you decide you want the money back in a 529 Plan, you can take your money back. Yes, you have to pay the taxes and a 10 percent penalty, but you get the money back. With a life insurance policy, if you decide to make a change, you will get some money back but it will be a fraction of what you invested. Another reason you should favor a 529 over a life insurance policy is the fact that the 529 has the potential for much greater growth. We all know how expensive college is; therefore, with a 529 Plan you can accumulate more money to be used for the child’s education.

In today’s world it seems they are always coming up with new ways to sell life insurance. Let’s not forget what life insurance is and that is, a means of covering risk. Life insurance is not an investment. My advice, if you’re ever approached about using a life insurance policy as an investment, run.

Good luck!

If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com.