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ASK KIM
Separate Insurance From College Savings
by Kimberly Lankford

I recently met with a financial advisor and asked if I should put money into a 529 plan or Coverdell ESA for my two kids, who are one and two years old. His response was "both are good but a universal life insurance policy is better" due to the fact you can borrow against the investment portion of the policy without paying any taxes. I'm underinsured as it is. Do you agree with his comment?

Sounds like the advisor is trying to earn a fat commission from a life insurance sale. If you want tax-free savings for college, stick with the 529 or Coverdell instead of the life insurance policy.

Even though you can borrow money tax-free from the universal life policy, there are several drawbacks:

• You'll usually pay much higher fees than you would with a 529 or Coverdell (without any extra tax benefits).



• The insurance charges tend to be a lot more expensive than they are for a term insurance policy.



• If you no longer need the coverage and end up dropping the universal life policy, you'll owe income taxes on all of your earnings -- including money you borrowed -- even if the cash is long gone.



• With a 529 and Coverdell, you won't owe federal income taxes as long as you use the money for education (tax-free withdrawals are guaranteed only through 2010), and can even get a state income-tax deduction for your 529 contribution in about half the states.



• But the biggest drawback is that any money you borrow from your policy isn't available as life insurance while the loan is outstanding. So if you carefully calculated how much money your family will need to replace your income if you die, then you borrow a big chunk of it for college costs, your family could end up with a lot less than expected from the insurance.

Because there are plenty of other ways to get tax-free savings for college, it's better to keep your life insurance separate from your college savings. That way you'll build a tax-free education fund without the strings attached, and you'll still have enough life insurance when you need it.

If you need the coverage for 20 or 30 years, go to InsWeb, AccuQuote or Insure.com to shop for a term insurance policy that can't increase your premiums. A healthy 30-year-old man, for example, can buy a 20-year level term insurance policy for as little as $320 per year; he'd pay about $500 annually for a 30-year level term policy. For help figuring how much life insurance you need, check out our life insurance calculator.

For information about saving for college, see 529 FAQs and The ABCs of Saving for College.