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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 children.
  • 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 withdrawn.

Some insurance salespeople encourage families to borrow money to help fund the life insurance policy. For example, they may suggest that the family get a second mortgage or a cash-out refinance to get money to invest. It does not make sense to be paying interest on a debt in order to earn a lower rate of return on an insurance policy, even after one considers the impact on taxes and financial aid.

Parents with children who are more than three years old should not consider variable life insurance as a college savings vehicle. Parents with children who are less than three years old will often be better off investing in a section 529 plan or Coverdell Education Savings Account.

The following is an excerpt from page AVG-15 of the 2012-13 Application and Verification Guide, a source of subregulatory guidance from the US Department of Education:

Retirement plans and whole life insurance. The value of retirement plans (401[k] plans, pension funds, annuities, non-education IRAs, Keogh plans, etc.) is not counted as an asset, but distributions do count as income -- they appear in the AGI if taxable and in questions 44 and 92 if untaxed. Similarly, the cash value or equity of a whole life insurance policy isn't reported as an asset, but an insurance settlement does count as income.

The full amount of the distribution is reported, whether it was a lump sum or annual distribution, and it will count as taxable or untaxed income, as appropriate. An exception to reporting pension distributions is when they are rolled over into another retirement plan in the same tax year.


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