Variable Life Insurance Policies
Certain types of life insurance policies, including variable life,
cash value life insurance and whole life insurance, combine life
insurance with a tax-deferred investment account, and provide
tax-free access to the cash value of the policy. Some insurance
companies promote these insurance policies as a college
savings vehicle because the value of the policy is sheltered from
financial aid need analysis formulas. But these life insurance plans
may benefit the salesperson more than they benefit the family.
The advantages of a variable life policy are as follows:
- The money is sheltered from the financial aid need analysis
process and so has no impact on financial aid.
- There are no limits on the amounts you can invest.
- The parent retains control over the money.
- One can withdraw or borrow contributions tax-free without penalty.
The disadvantages to such policies are as follows:
- Variable life insurance products tend to be expensive, with high
commissions and expenses. The total return on investment after
subtracting costs often makes such policies less attractive when
compared with other college saving options.
- The premiums on a variable life insurance policy will eat into the
gains you could make from the money you are paying.
- Unlike contributions to retirement accounts and some college
savings plans, the premiums are not deductible.
- Withdrawals from a variable life policy will reduce the death benefit.
- If you withdraw more money than the premiums you paid into the
policy, you will pay income taxes on the difference.
- Withdrawals from a variable life policy may cause the insurer to move
a portion of the remaining balance into a fixed-return account to
minimize the company's risk. This is more likely to occur when the
insured borrows against the policy, but it can also happen when the
insured withdraws funds from the policy.
- If you die prematurely, your heirs lose the value of the
investment account, getting only the death benefit.
- The claims that one can withdraw contributions without penalty is
not strictly accurate, since the surrender charges
penalize you for withdrawing funds before the 13th
year. This limits the usefulness of variable life policies as a
college savings vehicle to families with very young
- Borrowing from a life insurance policy can lead to interest
capitalization (adding unpaid interest to the debt), causing
interest to be charged on interest. This may ultimately consume all
of the cash value in the insurance policy.
- Withdrawals from a variable life insurance policy count as untaxed
income to the beneficiary on financial aid application forms. This
can have a severe negative impact on eligibility for need-based
financial aid, reducing aid eligibility by up to half of the amount