By Teresa Kuhn, JD, RFC, CSA
Earlier this year, the Obama administration proposed that 529 plans be taxed at ordinary income rates on both the initial asset value and all future returns on the asset. Since an asset’s value is in its’ future returns, this proposal amounted to double taxation.
While the plan was squelched due to public backlash, I have no doubt that more attempts to tap into 529’s will be made in the future. After all, a pile of money saved by responsible citizens is just too much for politicians to resist.
The government’s recent attempt to skim 529 plans highlights what is perhaps my biggest reservation about using them (or any government-controlled plan) to save for college.
It’s the fact that whoever builds the plan gets to call the shots.
Take Individual Retirement Accounts (IRA’s) for example. Since their introduction in 1974 as part of the Employee Retirement Income Security Act (ERISA), the rules have been tweaked and massaged multiple times and the idea of taxing those accounts is always hovering over Capitol Hill.
My point is this: most peoples’ financial strategies, whether saving for retirement, a new home, or college, are formulated with current rules and regulations in mind. These types of plans are marketed with the implicit idea that one is “secure” and “locked in” and it’s implied that the government will never change the rules. We’ve seen time and again that this is simply not true.
Every plan, whether government-backed, privately-managed or even plans funded by the type of specially-modified whole life that I advocate, has its’ own inherent weaknesses.
There is nothing that is 100% bullet proof. However, when you relinquish the amount of control that you must in order to participate in a government-backed plan, you incur an especially large degree of vulnerability.
Aside from vulnerability to the whims and hidden agendas of politicians, 529 plans have some other weaknesses of which you need to be aware. These weaknesses are some of the reasons why I recommend my clients fund a significant portion of college using specially designed whole life policies. Such policies have distinct advantages over 529 plans and can be used in conjunction with 529’s to create a more secure, more powerful strategy.
Many people who market 529’s claim their superiority over other options is due to the potential for growth. However, in nearly every state, 529’s possess a lack of investment options. This limits your ability to seek out your own preferred funds and you are limited to trusting that the folks in charge of your plan have made the wisest decisions.
In addition, even in states where there are some limited choices, you can only exercise your option to change once per year. You have zero margins for error.
Because of this, many of my clients have opted for the peace of mind, safety, and guarantees of whole life over the volatility associated with the stock market.
Another problem with 529’s is that their rigid rules allow the funds accumulated to be used only for “qualified” educational expenses. Certain things your child will need as he or she enters college might not be considered qualified expenses and will have to be paid out of pocket. These needs might well engender debt that the student might have a difficult time paying back.
Situations such as these are when having a properly managed modified whole life policy can come in handy. Not only can you take money out 100% tax free via loans and withdrawals from the policy, you can do so at ANY time for ANY reason. Imagine how useful this would be for students who have needs outside the definitions of a 529 plan.
Unlike government-sponsored plans, in which the regulations are highly restrictive, the flexibility of whole life allows for some very creative possibilities for college and retirement planning.
One of my clients came up with what I think is a brilliant strategy. She wants to fund a whole life policy for her child that would allow her to buy an apartment or condo in which the child can live during college, rather than a dorm room.
Imagine if, instead of paying tens of thousands of dollars to house her child in a dorm room, this parent could provide better housing for her student and acquire an income-producing property in the process. The property could become part of the parents’ retirement blueprint or they could gift it to their child upon graduation; allowing him or her to enter the world with a ready-made source of income. That would be an awesome head start for anyone, but especially for kids living in a world where a college degree no longer guarantees a job.
Another problem with 529’s is that contributions are limited. At the time of this writing, parents can contribute up to $14,000 (or $28,000 for married couples) each year without incurring gift taxes. By accelerating five years of investments, you can also, via a special election, contribute $70,000 at one time. ($140,000 for couples).
You might be saying at this point, “So what? Modified whole life plans also have contribution limits.” This is true, especially during the first few years of a policy. However, unlike 529 plans, the vast majority of whole life plans can be structured by a knowledgeable financial professional in such a way that contributions can easily exceed 529 contribution limits. Icing on the cake is the fact that whole life plans are not capped at the $350,000 lifetime limit of a 529 plan. With a whole life plan, you can have as much as you want in the plan and get the money out whenever you want.
Another significant difference between whole life and 529 plans that has the potential to blindside parents concerns beneficiaries. In a 529 plan you can change the beneficiary without penalty for any reason anytime you want. If Johnny Jr. insists he doesn’t want to go to college, you could switch the beneficiary to another relative. As long as that relative uses the money for qualified educational expenses, there are no penalties.
Whole life policies also allow you to change beneficiaries when you want, but with some big differences. In a whole life plan, you can designate anyone (not just a family member) as beneficiary, choose multiple beneficiaries, or designate a charity, church, or other institution as the beneficiary.
For some parents of college-bound students, the money they’ve saved in their 529 plan, even if they’ve managed to max it out, won’t be enough to pay for 4 years of college. This is especially true if their students have chosen certain careers, such as medicine, law, dentistry, or veterinary medicine or they choose to attend a more expensive private university.
For example, according to US News and World Report, the average cost of medical school tuition for the 2014-2015 year was over $50,000. That’s just tuition. Add in the costs of housing, food, supplies, and fees and a 4 year medical degree could cost most than $350,000.
The American Medical Students Association (AMSA) estimates that ever-increasing costs have driven students to seek financial aid and private loans. In 2015, over 86% of all medical students graduate will graduate with significant debt, some of which they must begin paying back within a few months of graduation.
A whole life policy could solve this in several ways. For one thing, as I mentioned before, there is no cap on how much you can have in your policy over a lifetime.
Another big advantage is that, while a robust 529 plan can impact your child’s financial aid score, money in a whole life policy does not factor into financial aid calculations. This could have a huge impact on the amount of aid for which your child qualifies.
The problem inherent in all planning is that you can’t see into the future. Your goofy little boy, the one who scribbles on your walls and breaks your furniture, could wind up with the talent to become a heart surgeon. Or he might want to start his own business right out of college, or teach school in Africa. You can’t possibly know what the future holds.
That’s why I recommend, even if you want to keep your college savings in a 529 plan, that you investigate the potential for regaining the use, control and liquidity of your money by starting a modified whole life policy.
That way, no matter what your child chooses to do in life, you can ensure that he or she has the very best start possible, without compromising your own financial future, and without having to leap through hoops to get access to your funds.Read More