Why Using the Correct Type of Life Insurance for College Funding is Critical
Have you ever heard the phrase, “grandparents have it easy! They get all the fun, then hand the kid back for all the hard work”?
If your family is anything like mine, that’s been said more than once during a car exchange before or after a long weekend with the grandparents. If your family’s REALLY like mine, it includes, among other things: crying siblings, burger king parking lots off the interstate, and inevitably, verbal shots against your parents informing them “Grandma and Grandpa let me do that!”
Don’t lie, we’ve all been there.
When Grandparents Don’t Have It Easy
Now that all the parents out there are in a frenzy, let’s back them off the ledge and talk about times when grandparents, or even great-grandparents, don’t have it easy.
In today’s economy, many grandparents are attempting to move money towards their grandchildren’s future college expenses. The rules around what dollars count towards your EFC (Expected Family Contribution) are complicated. Money from the student, parent, or grandparent could all count differently—for better or worse.
Don’t get me wrong, I support the idea of grandparents chipping in, and you won’t find anything here telling you not to pursue that, but we must watch when and how the funds are established. More importantly, take time to communicate your strategy with the parents you’re attempting to help.
A Real-Life Scenario: Great-Grandma’s Insurance Fiasco
Here are the nuts and bolts of a situation I found myself in three years ago:
- For the sake of privacy, we will call the clients in this story the Smiths.
- Mr. and Mrs. Smith had two children, both expecting to attend four-year schools—the oldest in the fall of the year we met and the youngest, two years behind the oldest.
- Great-Grandma set up a life insurance policy on Mr. Smith, paid through her estate upon her passing.
- The Smiths knew the policy existed and its purpose for their children’s college.
- But they were confused over how to use the money and were under the impression that premiums should stop that year, completing the idea that Great-Grandma implemented.
Simple enough, right? I figured I was walking into a one-meeting conversation, and they’d be off to the races.
Boy was I wrong.
This entire process started because the last policy statement seemed off in their minds. Once I got my eyes on it, I understood their confusion.
The policy was collecting a hefty premium, roughly $15,000 per year. That part wasn’t a surprise to any of us. The fact that the estate no longer had funds to cover the premium, and the notice was letting Mr. and Mrs. Smith know they were now responsible for payment—to Mr. Smith’s age 100—was a huge surprise.
I won’t lie, I was nervous for them. We knew there was a 0% chance the household could carry that premium, sitting a few months away from the first tuition bill. I knew I had to fix it, and the stress was already more than they could carry alone. So, we got to work and started making phone calls.
That’s when it got a little worse…. but a little better.
After discussing the case layout with a few of my colleagues, we came to the same conclusion: call the company holding the policy and get all our options on the table. We quickly realized few, if any, existed.
I’ve rarely had moments on the phone where I’m dumbfounded. You’re getting one today.
So, What Were Our Options?
Remember when I told you the premium was payable to age 100? Well, it turns out this company also didn’t allow policyholders to access any of the cash inside the policy until all premium payments were fulfilled.
Yeah….you read that right. Everyone knows 100 is the new 30, right!?
That left us with three options:
- Stop paying the premium, take the reduced death benefit and lose the cash.
- Create $15,000 in household budget, leaving a larger death benefit on Mr. Smith’s passing.
- Transfer the cash to a new policy, allowing access to the funds.
Right now, most of you are screaming “3! Pick 3! YOU HAVE TO PICK 3!” like you’re watching your best friend on the stage of Price is Right.
It wasn’t quite so simple. They have rules around what the new premium must equal in relation to how much money we were transferring—essentially bringing us back to number 2, forcing strain on an already tight budget.
Option 2 was still highly unattractive, perhaps not even feasible.
So, we created a fourth option.
Using an Annuity to Provide Flexibility
We moved the policy cash to an income annuity, paying out 50% to the parents for college tuition today and the other 50% to a new policy—keeping Mr. Smith insured while building cash for his second child’s future college expenses.
Sometimes, people find annuities confusing; it’s easy to do. The basic explanation of the solution is this: all the cash Mr. Smith had in his life insurance policy—while unavailable to use—could move without penalty to an annuity which pays him an even amount of money for a certain time period. When the time period is up, all the money deposited (plus some interest) is out of the annuity and the contract is finished.
As of two months ago, both kids attend the four-year schools of their choice, and we haven’t had a concern yet over covering the full tuition costs. We’ve kept the integrity of what Great-Grandma intended for her family and probably saved a family from a college disaster.
I hope you take away a couple of things from this story:
First, always put solid professionals in your corner. This easily could’ve been prevented if the original agent placed the right fit policy.
Second, don’t let poor communication cause rifts in your intentions. We’d like to think everyone will remember what was intended, but it rarely happens. Sit down with your family members and place writing in legal documents detailing how you’d like your plan to play out.
After all, you’d hate missing another opportunity for your grandkids to say, “But Grandma and Grandpa let me do that!”