529 plans vs. life insurance

[kvanvoorhis]

A friend of mine has written an e-mail with the following story:

"I am working with a financial person who is helping with financial aid applications. I've saved for college because I thought we'd be earning too much money to qualify for any financial aid. Now that Neal's not working and I'm not working (though will be deciding most likely between 2 options pretty soon), our income is $0, and the adviser is recommending we put the 529 money into a life insurance policy. I have the proposal from him and can send. Once I heard "life insurance," I decided to ring you. It feels sketchy to me. And yes, I'd have to liquidate the 529's, pay 10% penalty and tax on all of the gain. He still thinks we'd get lots more money in aid with our awful financial situation.

I've read some articles on the internet from credible sources, but they're mostly about the decision to save in 529 or life insurance, nothing about way down the road where I am as outlined above."

Any thoughts on this?

[bmcnett]

I listen to the radio shows "The Clark Howard Show" and "The Dave Ramsey Show" daily - they have four hours of content every weekday to go through as I drive to and from work.

These shows are about how to get rid of debt, avoid scams, and build wealth.

One of the most consistent pieces of advice they give, seemingly at least once a day, is to never use insurance as an investment.

They recommend using term life insurance only, to protect against the death of someone who brings income into the family.

All other kinds of insurance, they explain, are investments - but very poor ones, with very high fees and very low rates of return.

Both of these radio shows steer people towards Vanguard and other low-fee brokerages, where you can find investments that consistently return 7-9% with low long-term risk.

[bmcnett]

As for 529 plans, the radio shows recommend these, because they grow tax-free in a manner similar to a Roth IRA. That is to say, that as long as you use the proceeds for qualified education expenses, you never pay tax on the profit from your investment in a 529 plan.

The only question they raise is this: if a close relative doesn't ever use the money for college, you risk being penalized 10% and paying taxes on the profits when you withdraw from a 529.

Interestingly, if the beneficiary of a 529 receives enough scholarships that they don't need the 529 money, then you must pay tax on the profits but do not need to pay the 10% penalty when you withdraw.

[dcandmc]

It's difficult to offer detailed feedback without more details, but I would be EXTREMELY wary about following any advice to take the tax and penalty hit for liquidating a 529 account in order to "invest" in life insurance, all with the goal of increasing financial aid. Unless you know which specific school will be offering financial and that in fact this scheme will result in more aid, this plan is a crap shoot with very bad odds.

[dcandmc]

Adding this:

Bad College Advice - Stash Your Child's Assets in an Annuity

[Lawhorne27]

I also think that insurance should not be used as the investment. If you actually want to invest your money for making more money with it then you can pick from various other modes such as mutual funds and forex investments etc. It would be better to consult a renowned certified financial planner to know more about these options.