The Truth About Endowment Life Insurance Policies

Endowment life insurance is a type of insurance that is frequently disguised as a college savings plan. As long as you make the fixed monthly payments, the endowment life insurance policy promises a risk-free, guaranteed return on a specified date. Furthermore, the cash value is not deducted from your child's financial aid eligibility. Could this be the kind of college savings plan you've been looking for?

Let's see if the stated benefits of these policies live up to their claims.

Essentially, these policies combine term life insurance with a savings plan. You decide how much you want to save each month and when you want the policy to mature as the policyholder. When the policy matures, you are guaranteed a certain payout, known as an endowment, based on your monthly contributions.

This endowment can then be used to pay for your child's college tuition, fees, books, living expenses, and other expenses. If you die before the policy matures, your child will receive the payout as your death benefit and will still be able to pay for college.

Are Two Products for the Price of One the Best Option?

Endowment life insurance may appear to save you money by bundling products in marketing materials. But is that correct?

For young and healthy customers, term life insurance, which is included in an endowment life policy, is inexpensive. You could get more college savings and more insurance for the same money if you split your monthly payment to the endowment life policy and used part of it for college savings and part for term insurance. Endowment life insurance is not the only type of life insurance that combines savings and insurance.

However, if your primary goal is to save money, these policies aren't usually the best option because not all of your money goes toward your savings goal. Some of it is used to purchase insurance.

Risk-Free May Not Help Long-Term Savings Goals

Endowment life insurance policies are not subject to investment or interest rate risk. On the other hand, low-risk investments typically provide poor returns. In other words, you will not be able to save enough money for college. Because the earnings on endowment life insurance policies are taxable, your savings may not even keep up with inflation.

These plans should reduce tuition costs by allowing parents to pay for college years ahead of time and avoid price increases. One potential disadvantage is that many of these arrangements are only valid for a state school in your home state at the time the account was opened. That isn't necessarily a bad thing, but no one can predict your and your child's future preferences.

529 Savings Plans

The second option is a 529 college savings plan, which allows you to choose how your savings are invested. Ideally, you would invest some of your savings in stocks and some in bonds, gradually shifting away from stocks as your child approaches college age. This strategy is similar to how you save for retirement—you take more risk at first when you have a long time horizon, and as the day when you need the money approaches, you move into lower-risk investments to ensure the money is there when you need it.

If you're truly risk-averse and willing to accept lower returns, FDIC-insured money market accounts, savings accounts, and CDs can help you avoid investment risk. Whatever investment you choose, a college savings plan will help you maximize your returns by lowering your tax liability.

There are more reasons to consider 529 plans now that the Setting Every Community Up for Retirement Enhancement (SECURE) Act has been passed. The SECURE Act broadened the definition of "qualified higher education expense" in 529 plans, making them more useful. A 529 plan can now be used to pay for certain expenses associated with registered apprenticeship programmes. Fees, books, supplies, and equipment are all covered as long as the apprenticeship programme in which your child is enrolled is approved by the Secretary of Labor. The SECURE Act also allows you to use up to $10,000 of your 529 savings to pay off your child's qualified student loan principal and/or interest.

It Doesn't Count Against Financial Aid Eligibility

When students attend college, both 529 plans and education savings accounts lose 5.6% of their value. The FAFSA considers this money and raises the student's expected college contribution by up to 5.6%. It's critical to understand how your savings and investment decisions will affect your child's financial aid eligibility so that you don't overestimate your ability to receive aid.

Endowment life insurance does not have the same impact on a student's financial aid eligibility as other college savings vehicles. However, this "advantage" is not a compelling reason to choose an endowment life insurance policy. Even after the 5.6% tax, 529 plans and ESAs will provide more bang for your college investment buck than endowment life insurance.

You Don't Need a Medical Exam

Endowment life insurance policies, unlike many other types of life insurance, do not require a medical exam to qualify. Because of this benefit, an endowment life insurance policy may be a good option if you have a medical history that precludes you from qualifying for an exam-contingent policy. It's also good news if you'd rather avoid the time and discomfort of the exam, as well as the questions about your medical history that come with it.

You can, however, obtain a standard term policy without taking an exam. This feature is not exclusive to endowment life insurance policies. Keep in mind, however, that the face value of any no-exam life insurance policy will be relatively small—enough to help a little, but probably not enough to meet every need you're attempting to provide for.

Take a Second Look Before Buying

Endowment life insurance, unlike a 529 plan or a Coverdell ESA, is not a college savings plan; it is simply marketed as such. It's just life insurance, and the proceeds can be used for anything.

If you are extravagant, no financial product can fully protect you from yourself. You can, for example, borrow against your endowment life policy, and your benefit will be reduced by the outstanding loan amount as well as the interest you owe on that loan. You will also not receive the full benefit if you do not pay your premiums in full, and the policy will lapse if you stop paying your premiums. Because of these options, endowment life insurance provides no protection against poor spending decisions made by you or your child.

Frequently Asked Questions

Why Choose Endowment Life Insurance? Are They Just for Saving for College?

Despite being marketed as such, these are not college savings plans. These are simply life insurance policies. The accumulated cash value payout can be used for anything without penalty.

One advantage is that, unlike many other types of life insurance, you do not need to take a medical exam to qualify for an endowment life insurance policy.

Do Options Exist That Are Explicitly for Saving for College?

Prepaid tuition and 529 savings plans are specifically designed to assist with future college expenses. Prepaid tuition plans allow you to pay in advance and lock in current tuition rates for future educational costs. A 529 plan allows you to invest in stocks and bonds, gradually shifting away from stocks as your child approaches college age. This method is comparable to how you save for retirement.

The Bottom Line

Endowment life insurance policies appear to be a good way to save for college, but they fall short of your other options. They don't provide enough insurance or college savings to meet the majority of people's needs, and they don't provide the best bang for your buck.