How to Pay for your Grandchildren’s College Tuition Before they Are Even Born
Ok, so no surprise – since you are reading it on a life insurance blog, this might have something to do with life insurance…
My last article on gifting looked at life insurance as a way to multiply your charitable giving by rearranging your monthly cash donations into premium payments that provided a major gift to the charity upon your passing.
This strategy isn’t just for charity
This strategy works just as well if you want to give to your grandchildren too. You can’t do this with just anyone because one of the key tenets of life insurance is that the death of the insured person (that’s you) must cause a negative economic impact to the beneficiary. Otherwise you could just be gambling on the death (and are even incentivized for them to suffer some ‘accident’)
In case you were wondering, yes absolutely in the old days people took life insurance policies out on strangers and then tried to kill them. The early history of life insurance is filled with lawless tales of backstabbing, double crossing, and outright fraud from every party (including the companies themselves).
Thankfully, in our modern society we have laws preventing this kind of monkey business, and insurance is now one of the most highly regulated industries out there.
One of the clarifications that have come down from those regulations is that grandparents are allowed to make their grandchildren beneficiaries of their policies, because grandchildren are negatively impacted financially by their grandparent’s passing.
So, what were we talking about again?
Let’s get back on topic: Gifting to grandchildren using life insurance! There are two popular ways to give to grandchildren using life insurance. The more popular way is both less effective and ethically ambiguous – it’s the Gerber Grow Up plan!
The second way, which is less popular for some reason, is to purchase a life insurance policy on yourself with your grandchildren as the beneficiary. Let’s take a deeper look at how each strategy works:
Buying life insurance on your grandchildren
Buying life insurance on your grandchildren, as opposed to yourself does have some benefits, which coincidentally helps people at opposite ends of the financial spectrum. The two benefits of buying directly on a grandchild over buying life insurance on yourself with your grandchildren as a beneficiary are:
- You can do it for less money. The average Gerber plan is between $9 and $19 a month.
- If you want to do it for (a lot) more money, you can pass an annual gift up to the gift tax exemption limit ($15,000 in 2019) into a policy held within an Irrevocable Life Insurance Trust per grandchild to remove it from your estate. (You can see how this gets complicated quick. You can even exceed this amount without paying taxes, but that involves talking about lifetime exemption depletion and GSTT issues)
Unlike purchasing life insurance directly on your grandchildren, using life insurance as a planned is going to require a permanent policy placed on your life, so expect on spending at least a couple hundred dollars a month if you’d like to give $100k or more.
You may be tempted to take out a term policy with the intention to pass away before the term is up, but this will just lead to disappointment when you reach the maturity date alive and well. All of those premiums that were supposed to go to the next generation just went to waste without you needing the insurance coverage.
In contrast to the above, with the Grow up plan (and other plans like it), you can pass cash value to your grandkids for as little as $10 bucks a month.
That policy is not going to give your grandchildren very much cash value at all, but it definitely doesn’t require the commitment of the premium payment that you will need to give your grandchildren a tax free lump sum gift.
It does expose something deeper about the marketing however – the simple fact is that most children don’t need life insurance policies – modern day American children are statistically extremely unlikely to perish or be unable to attain coverage when they become an adult at 18.
This is where the ethical dilemma comes in (at least for us agents) – As a Certified Financial Planner, I don’t think children usually need life insurance, and even though they can access the cash value in the policy while they are still alive, it’s much easier to just transfer the cash directly, whether it be in guardianship (their parents have control) or through a trust.
As you start to get into estate tax issues the calculus changes a bit, which is why ILITs (Irrevocable Life Insurance Trusts) can make sense, but 99.5% of the population does not require that option.
Even when the avoiding estate tax comes into play with an ILIT, you are still looking at potential GSTT (Generation Skipping Trust Taxes) issues, but obviously anyone who has that concern should have their insurance agents, financial planners, and accountants working hand in glove to provide you the best solution.
All that being said let’s take a look at the other option:
Buying life insurance on yourself FOR your grandchildren – the better option
This second option makes a lot more sense for people who live comfortably, but don’t have or want the sophistication of a $20 million dollar estate plan (and is the point of the article!).
Buying life insurance directly on yourself with your grandchildren as beneficiaries is a simple way to amplify the amount of cash above the original amount you had planned to give them. Using the right policies, you can turn a monthly payment into a large legacy gift that they will remember you by.
$371 a month isn’t affordable for every family, but for those who this wouldn’t be a burden, it’s a small price to pay for completely paying off your grandchildren’s college costs.
Here’s how we can do this
In order to make this strategy work, we need:
- An appropriate life insurance policy to purchase
- A way to make sure the cash goes to your grandchildren and is used appropriately
Part 1: Picking the right life insurance policy for a legacy transfer
Believe it or not, picking the right life insurance policy is actually the easier of the two. We need to pick a life insurance policy that will last as long as you do, and for that we have 2 good options: An Indexed universal life (IUL) or a Guaranteed Universal life policy (GUL). A term policy is not appropriate in this case because you could easily outlive it.
Option #1 The Guaranteed Universal Life Policy
A Guaranteed Life Insurance Policy is going to be your cheapest fixed option as it provides a guaranteed lifetime benefit that you can’t outlive, and a fixed payment that doesn’t increase. These policies are very much what you ‘What you see is what you get’. There’s no overly optimistic scenarios in which a life insurance agent can promise you the world, only to have your policy collapse because of unrealistic expectations. It has the guarantees of whole life at less than half the cost.
If you hear about something like a term to age 90 or term to age 100, these are also GULs that have been customized to be a bit cheaper, in exchange for a less than lifetime fixing of the premium. It is possible to use one of these policies, but you will need to start putting more money into the policy to extend the insurance if it looks like you’re going to outlive the term.
Option #2 The Indexed Universal Life Policy
A potentially better choice for younger or more risk tolerant individuals – the closely related cousin of a GUL, an Indexed Universal life policy allows you to trade away some of the guarantees in exchange for a better upside possibility.
IULs get their souped up potential from the fact that the policy is credited with interest in relation to a equity market index that you choose (The Dow Jones or S&P for example).
Historically, the equity market has wildly out performed the bond market (which is where life insurers are otherwise required to invest the rest of their general account in). Unlike Variable Universal Life Insurance plans, IULs have a floor that ensures you can’t lose money from bad investment returns
You can also get Indexed Universal Life policies with guarantees to age 80 or 90, which gives it the same worst case scenario as a GUL policy way past your expected life expectancy.
This is the best option for younger people, but as you get older, you have less time to make up for any bad years in the stock market. If you are older than 60, it’s probably better to stick with the GUL.
What about a Whole Life Policy?
You could absolutely use a whole life policy here, but I would not recommend it. Whole Life policies are much more expensive for the same amount of coverage and generally only make sense when you need cash value.
We are using this insurance as a strategy to give away money (ie you don’t need it) there is no point in picking a less efficient policy to do the same job.
How to pick the best life insurance plan for you
Remember, what we are trying to do here is leverage a monthly payment into a large life changing legacy.
If you are doing that for your grandkids, chances are you’ll want want to make sure it is set in stone, so using a Guaranteed Universal Life policy that provides lifetime coverage is the simplest and easiest option.
You could certainly shave off some monthly costs by trying to use an IUL or GUL with guarantees that only last until age 90, but you have to be ok with potentially shoring up those policies with a higher premium if end up living into your late 90s – which is often when your spending goes up on healthcare.
We didn’t talk about relative age yet, either.Because the policy is on your life, the healthier you are and younger you are, the more death benefit you’ll be able to get for the same amount of premium.
If this strategy is interesting to you, it’s important to get started right away, because even minor health problems could reduce the amount you are able to give your grandchildren by more than 50%
Part 2: Making sure the money is used for the right reasons
Here is the trickier part – this money is to pay for your grandkid’s future college, and we want to make sure that it is not used for any other purpose. There are essentially have two ways to accomplish this, the right way and the quick way.
The Right Way – Use a Trust
As you may or may not know, trusts can be the beneficiaries of life insurance policies, and often there are major benefits of having a trust. A trust is a set of legally binding rules that the trustee must follow.
You’ll have to match up with an estate attorney to do this correctly, and yes it will cost some money to do. Estate Attorneys do not come cheap, so make sure you know exactly what you want before you go into their office.
With a trust you can specify exactly the terms under which your grandkids are allowed to access the cash and exactly what they can use it for – and they don’t even have to exist yet for you to set this plan up! (If your children disappoint you by never having kids, you can always have that portion donated or paid out to your children).
To prevent the cash from sitting around not gaining interest if you were to pass early, you can also leave instructions for the Trustee to make sure that the funds are invested prudently.
If you already have a living trust, you should be able to amend it to add a provision for the funding of college, but again contact a qualified Estate Attorney for legal advice.
While you can never take your money with you, you can certainly still exercise control over it long after you’re gone.
The Quick Way – Designate their parents who will promise to use the cash for college
I don’t recommend that you do it the quick way. Being lazy always leads to poor outcomes and being with lazy with money doubly so. The worst fights a family can have are over money, and you really don’t want to have your descendants each other over a large sum of money.
Again, this is not recommended at all but people do it, so you might as well know about it:
You can simply name your children as beneficiaries and make them promise to use that money for their children’s college education. Hopefully you can already see all of the areas where this can possibly go wrong. Without a trust, there’s no legal requirement that any of this happen.
Your son or daughter (if they are that type of person) could just as easily spend that money on a beach house the day after the day after they get it. Without the trust standing as an independent legal entity, they are absolutely entitled to do whatever they would like with that lump sum.
This strategy only works if you are under 70, relatively healthy and have young grandkids or don’t have them yet but you are expecting them. If your grandchildren are too old, its possible that they’ll graduate college while you are still paying for the insurance! Though they could always use this money for something like a downpayment, or to repay student loans, that wasn’t the original plan.
Also, if you aren’t healthy enough, or if you’re getting up there in age, the price of the insurance will make it so that it doesn’t make sense to try to execute this plan. The last thing you want to do is have to surrender the policy due to non-payment because of an inability to pay it.
If you can’t afford it, or if your income is limited because Social Security is the majority of your income, you are better off just giving your grandchildren money directly using a 529 plan.
However, if you do have an above average income and are interested in seeing how this strategy can fit your specific situation, you can schedule a no obligation meeting with me, or email me at [email protected] to review your specific situation and provide a customized quote.