Can You Use Life Insurance for College Savings?

Paying for college can require years of planning, and families often look beyond traditional savings accounts for additional options. Permanent life insurance can build cash value that may be tapped for education expenses, offering flexibility alongside a death benefit. However, using life insurance for college comes with costs, risks and trade-offs that are important to understand before making it part of your savings strategy.

Consider talking to a financial advisor, who can help you decide on the best way to save for college costs.

Understanding Life Insurance and Cash Value

Life insurance comes in different varieties, but the two main categories are term and permanent life. Term life coverage insures you for a set time period. If you pass away during the term, the policy pays out a death benefit to your beneficiaries that they could use to pay for college or other expenses. If you outlive the term, the policy terminates and no benefit is paid out.

Permanent life insurance, on the other hand, covers you for the duration of your life as long as premiums are paid. Certain types of permanent life insurance can also include a cash value component. As you pay in premiums monthly or annually, part of that premium is deposited into an interest-bearing account. You can then withdraw cash value or take out a loan against it during your lifetime.

Term life, meanwhile, doesn’t build cash value. However, it’s generally less expensive than permanent life insurance coverage. If you’re specifically interested in accumulating cash value with life insurance, you might be able to do that with a permanent whole life, universal life or variable life policy. The main difference between them lies in how the cash value account earns interest.

Can You Use Life Insurance for College Savings?

Permanent life insurance policies, such as whole life and universal life insurance, can potentially be used as a supplemental source of college savings. These policies may build cash value over time, which the policyholder can generally access through withdrawals or loans to help cover tuition, housing and other education costs.

Part of the premium paid into a permanent life insurance policy goes toward the cost of insurance, while another portion may contribute to the policy’s cash value. As that value grows, the policyholder may be able to borrow against it, potentially without recognizing taxable income as long as the policy remains in force and certain tax rules are followed.

One potential advantage is flexibility. Unlike education-specific accounts, money accessed from a life insurance policy is generally not limited to qualified education expenses, so unused funds could potentially support retirement, emergencies or other financial goals if a child receives a scholarship or does not attend college.

However, permanent life insurance can be expensive and complicated. Premiums are typically higher than those for term life insurance, while fees, surrender charges and insurance costs can reduce cash-value growth, especially during the early years of the policy.

How to Use Life Insurance for College Savings

If you’d like to tap into your life insurance policy to pay for college, the first step is making sure that you can actually do so. A quick call to your insurance company or a review of your policy documents should tell you whether you have a term life or permanent life insurance policy and if it’s permanent, where there’s a cash value component.

Assuming that your policy has some cash value, the next step is deciding how to go about withdrawing it. Your insurance agent should be able to walk you through the different options. You may also want to talk to your financial advisor to discuss whether it makes more sense to borrow from your policy, withdraw the cash value or surrender it altogether.

If you’re opting for a loan or cash value withdrawal, you’ll need to know how much cash value is available and what amount to withdraw for college costs. You can then make the request to the insurance company to get the cash. Life insurance loans don’t require all the usual hoops associated with personal loans or student loans, though there might be some paperwork you need to fill out.

Once everything is finalized, the life insurance company will cut a check to you for the cash value that you’re taking out. You can then deposit it to your bank and once it clears, use the money to pay for college expenses.

Should You Use Life Insurance to Pay for College?

Life insurance isn’t designed to be a college savings vehicle, per se. Its primary function is to help people leave a financial safety net behind for their loved ones should the worst happen. Life insurance beneficiaries can use the death benefit from a policy to cover a wide range of costs, including mortgage payments, everyday expenses, final expenses and credit card bills.

Education expenses can also be added to that list and there are a few good reasons to consider using life insurance for college savings. Here are some of the advantages of life insurance as a college savings tool.

It’s flexible since you can withdraw or borrow against your cash value and use it to pay education expenses at your own pace.
Life insurance policies and any loans you might take from them, typically don’t affect a student’s ability to qualify for financial aid.
You can continue accumulating interest until you’re ready to withdraw it and you’re not penalized if your child decides not to go to college.
Coverage is lifelong, which means you could use your cash value to fund college for your children, grandchildren or even great-grandchildren.

There are, however, some downsides to using life insurance for college savings in lieu of a tax-advantaged plan, such as a 529 account or even a Coverdell Education Savings Account (ESA). Here are some of the most important things to keep in mind.

Cash value can take time to accumulate in a permanent life insurance policy and it’s possible that you won’t have enough to pay for college costs when the need arises.
A 529 college savings account may offer a higher rate of return, along with tax advantages.
Permanent life insurance can be more expensive than term life insurance when you factor in the premiums, upfront fees and recurring fees that you might pay.
Withdrawing or borrowing against cash value shrinks the death benefit that you’re able to leave behind for your loved ones.

A financial advisor might recommend incorporating life insurance into your college savings plan, but as just one piece, not the main focal point. For instance, you might set up a 529 for each of your children and contribute money to it each year that grows on a tax-deferred basis. When your child is ready to go to school, you can withdraw that money tax-free as long as it’s used for qualified higher education expenses.

If you pass away while your child is still in school, your life insurance policy can help to cover any remaining costs to help them finish their education. And if you have a 529 plan but your child doesn’t go to college, you could always transfer it to another beneficiary without a penalty.

Bottom Line

Using life insurance for college savings is something you might consider if you have a permanent policy. It’s important to consider all the options for funding higher education, including a 529 plan or Coverdell account, to determine what best fits your needs. And if you don’t have a life insurance policy yet, you might want to get a rate quote to get an idea of how much you’ll pay for coverage.

Insurance Planning Tips

If you’re not sure where to get started with college planning, a financial advisor can help. An advisor can review your financial situation and your student’s estimated needs, then offer solutions for meeting them. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
When comparing life insurance policies, it’s important to consider not only what you’ll pay but how much cash value you might be able to accumulate. Whole life policies, universal life policies and variable life policies can all take very different approaches to growing your cash value.