With college costs and student loan balances on the rise, many people are trying to figure out how to maximize their financial aid, especially if they have a lot of assets that could reduce their eligibility. For example, we recently received a question on our Facebook page from someone whose financial planner recommended that they sell $100k worth of stocks and move the money into a cash value life insurance policy to shield it from impacting financial aid and to collect steady interest while protecting it from losing principal. Does this make sense? Let's look at some factors:
How much will your assets impact financial aid?
Assets in the name of the student tend to reduce financial aid eligibility by about 20% but only up to 5-6% if they're in the name of the parents. (That's one reason why it may be a good idea to keep money out of your child's name.)However, the exact impact can vary greatly depending on your situation. In some cases, your income may be so high that you won't qualify for financial aid anyway. In others, the assets may be too small to have an affect.
Since different schools use different aid formulas, your best bet is to check the school's web site for their net price calculator, which gives you an estimate of your actual out-of-pocket costs based on your projected financial aid eligibility. If you don't have a specific school in mind, you can use this site for a generic calculation. Either way, you can enter your situation with and without the assets to see what difference they make.
What's the best way to shield your assets?
If your assets are making a significant difference, there are several places you can put money that could prevent them from reducing your financial aid (depending on the school's particular formula). One option is retirement accounts. You can contribute up to $5,500 or ($6,500 if you turn 50 or older this year) this year to an IRA. If you fall under the income limits, you can also get a deduction on traditional IRA contributions or make Roth contributions that can eventually grow to be tax-free. While you can't contribute assets directly to an employer-sponsored plan like a 401(k), you can contribute them indirectly by simply increasing your payroll contributions to the plan and using the assets to replace the lost income. Finally, if you're eligible for an HSA, they're also not generally included in financial aid formulas.
Another option is to simply use the assets to pay down debt. This makes the most sense for high-interest debt like credit card debt but you can also pay down mortgage and student loan balances. You may not save as much in interest as you could earn by investing the money but there's also a peace of mind in having less debt, especially when you or your child is about to go off to college.
Of course, these options have some downsides too. You may already be maxing out retirement and HSA accounts and there are limitations on how you can invest and access your money. You may want to earn more than you would save by paying down debt or you may want to have access to the money for things like those upcoming tuition bills.
Does cash value life insurance make sense for you?
That's where the option of cash value life insurance comes in. The appeal is that the cash value in a life insurance policy is typically not included in financial aid formulas and depending on the type of policy, the cash value can earn interest, dividends, or investment gains. In some cases, your principal is guaranteed by the insurance company and there may even be a guaranteed rate of return. Finally, the cash value grows tax-deferred and you can borrow from it anytime without owing any taxes.
So what's the catch? First, do you even need more life insurance? Part of your payments will go to the cost of insurance so you want to make sure you're not paying for something you don't need. You can estimate your life insurance needs here. Also, the cost will depend on your age and health status so it may be prohibitive if you're older or not in good health.
Second, you'll want to understand your particular policy. What exactly is guaranteed and what is merely a hypothetical rate of return? In particular, variable policies have market risk and you may even be forced to make additional payments to keep the policy in force.
Finally, understand the fees you're paying. These policies are notorious for high fees that can severely reduce your earnings. In fact, much of the initial premiums are used to pay commissions to the agents that sell them.
As you can see, there are a lot of issues involved. If you're in doubt, get a proposal from an insurance agent and then get a second opinion on it from an financial planner whose not compensated based on your decision. Any fee you may pay can easily be outweighed by a mistake that costs you in fees, investment losses, or reduced financial aid. You can also check with your employer to see if they provide access to unbiased financial planning at no cost to you.
Do you have a financial question of your own? Feel free to submit it in the comments section below or on our Facebook page. I or one of our other planners can then answer it here or on our Financial Finesse blog.
Erik Carter, JD, CFP® is a senior resident financial planner at Financial Finesse. For speaking opportunities on personal finance issues, please email ffpress@financialfinesse.com.
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