How To Use Insurance To Fund Your Kids Education
Universal life policies can supplement education savings
The thought of buying life insurance for children (or grandchildren) often has slightly morbid overtones.
However, with the advent of universal life insurance, it can be both an effective wealth transfer strategy as well as a valuable source of educational funding.
By including the use of the insurance as one of the potential investment choices available, we are not suggesting that it supercede the benefits of maximizing saving vehicles like a registered education savings plan (RESP).
Instead a universal life insurance policy taken out on the life of the child can be a worthy choice of additional savings for their benefit.
The mechanics are straightforward. A grandparent or parent applies for a life insurance policy as its “owner” and names the child as the insured.
The owner of the policy names a beneficiary for the policy’s death benefit which can be the same as the owner or different.
A grandparent may choose to name the parents as the beneficiaries, for example.
In the case of children, insurance companies rarely require an extensive medical exam. Usually, only a simple medical questionnaire is completed unless the amounts of insurance are very high.
Once the policy is approved the owner will then pay the insurance premiums.
The reason that a universal life policy would be used is the ability to shelter additional dollars within a tax-sheltered environment beyond the minimum premiums required to fund the low insurance costs for a child.
Depending on the face amount of the insurance policy and the age of the child, significant additional dollars can be committed to the policy, which can then be invested in a variety of investment funds to grow over the life of the policy, tax-sheltered.
In the table below we illustrate how a newborn (age 1 month) is provided with a life insurance policy with a face amount of $475,000.00.
In this case, the actual insurance costs of this policy would start at only $18.17 per month ($218 per year), increasing annually until age 17 when they would level out at $99.33 per month ($1192.00 per year) for the remaining lifetime.
Under the provisions of the Income Tax Act, one can supplement these minimum premiums with additional deposits of up to $5350.00 per year if desired. The tax-exempt maximum premiums will vary according to the insured’s age, face amount of the policy and the insurance company’s actuarial tables.
Purchasing $475,000.00 of life insurance for a newborn may seem excessive but when you consider the potential wealth transfer effect emerging with significant estates being passed down to the next generation and their inherent future tax liabilities, the concept is not that farfetched.
In addition, the child’s insurability, for this policy at least, would be assured which also has some value in a world battling a variety of incurable diseases that might prohibit insurability.
Insurance companies will request that the parents of the child be adequately insured before considering issuing a policy on the child.
When the insured turns 19, or at any point in the future, the owner of the policy might choose to suspend future premium payments and transfer the ownership of the policy to the child. (This should be done prior to any withdrawals by the child.)
This transfer of ownership from a parent or grandparent to the child will not trigger any taxation to either party since it is made from one generation to the other.
Since the owner has paid the additional premiums up to this point, a substantial cash value has been built up in the policy, allowing future premiums to be suspended while keeping the policy in force.
In addition, the child now has access to the policy’s cash values.
They can decide to start drawing on these cash values to pay their university costs (or anything else their heart desires). Since the policy is now owned by the child, income is taxed at his/her marginal tax rate, which is likely much lower than that of the parent or grandparent.
The only concern would be depleting the funds to a degree in which you jeopardize the coverage later on. Alternatively, the child can simply leave the policy untouched and see the wonders of tax-deferred compounding as the overall cash values and death benefits of their universal life policy continue to build up.
Once they have become orthopedic surgeons or leveraged buyout specialists with their own limitless – but taxable – income, they may decide to build up the policy with additional premium payments for the potential tax-sheltering benefits.
Policies taken out on children can have both significant long-term investment and insurance benefits. In fact, they may be the investment of a lifetime.
