Q: My wife and I are in our mid-40s. We are pretty well off financially. … Our saving for retirement looks strong. We also have two children, ages 14 and 11. We have done some monthly college savings since they were quite young, with 529 plans for each of them, but these accounts aren't as strong as our retirement accounts. We feel like we really want to step up our monthly college savings by quite a bit. One obvious option is to simply crank up our monthly contributions to their 529 plans. However, we have a financial adviser who is suggesting buying variable universal life insurance as a savings vehicle for college. The given reasoning is that money in such accounts can't be included in calculations for financial-aid eligibility. … Supposedly, there are some tax benefits as well, but, to be honest, VUL sounds very complex and I'm not sure I totally understand it. Do you have thoughts on using such a vehicle for college savings as I've described?
A: I'm skeptical about the case of savings for college with a variable universal life policy (or any variation on the permanent life insurance option) for most people, despite some definite attractions to the strategy. A basic caution in personal finance is if you don't understand the workings of a product or strategy, you shouldn't invest your hard-earned money in it.
Here's a different way of expressing my wariness: If a variable universal life policy makes sense as part of your overall household financial plan and the option of tapping the savings to help pay for college is a side benefit, then fine. But I wouldn't buy the policy to pay for future college costs.
Like all insurance policies, permanent life insurance comes with a death benefit. The policy also has a tax-advantaged savings account. Variable universal life offers the option of investing in mutual funds like stocks and bonds. The lure for saving for college with a variable universal life policy is that the money isn't usually considered in the financial aid calculation. You can withdraw funds from the cash value account or take out a loan against the cash-value part of the policy when it comes time to pay the college bill.
Variable universal life policies tend to be complicated, high-cost product. You'll want to take into account all the associated costs of the policy before buying one. With the typical policy, the cash value compounds slowly at first since premiums are covering commission and other upfront costs, a drag on returns in the early years. Your oldest is likely to be heading off to college relatively soon, in four years? (Doesn't the time fly?) That doesn't seem like enough time to me. I would think you'd want at least a decade of compounding. So, check out the numbers.
With the 529 plans, you get to withdraw the earnings tax-free. Yes, you'll take a slight nick on financial aid, but 529 plans have improved in recent years. Fees are coming down. Asset allocations are getting more conservative (and you should be conservative with the money for your oldest.) Savers in 529s have more fixed income options than before. The 529 seems like the simpler, more cost-effective choice for many people.
Chris Farrell is economics editor for "Marketplace Money." His e-mail is email@example.com.