Dear Liz: We have a son who is a high school junior and who is planning on going to college. We met with a college financial planner who suggested we put money in a whole life insurance policy as a way to help get more financial aid. Is that a good idea?
Answer: Your "college financial planner" is actually an insurance salesperson who hopes to make a big commission by talking you into an expensive policy you probably don't need.
The salesperson is correct that buying a cash-value life insurance policy is one way to hide assets from college financial planning formulas. Some would question the ethics of trying to look poorer to get more aid, but the bottom line is that for most families, there are better ways to get an affordable education.
First, understand that assets owned by parents get favorable treatment in financial aid formulas. Some assets, such as retirement accounts and home equity, aren't counted at all by the Free Application for Federal Student Aid, or FAFSA. Parents also get to exempt a certain amount of assets based on their age. The closer the parents are to retirement, the greater the amount of non-retirement assets they're able to shield.
Consider using the "expected family contribution calculator" at FinAid.org and the net cost calculators posted on the websites of the colleges your son is considering. Do the calculations with and without the money you're trying to hide to see what difference the money really makes.
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Most families don't have enough "countable" assets to worry about their effect on financial aid formulas, said college aid expert Lynn O'Shaughnessy, author of "The College Solution." Those that do have substantial assets have several options to reduce their potential impact, including spending down any custodial accounts, paying off debt and maxing out retirement plan contributions in the years before applying for college.
Another thing to consider is that most financial aid these days comes as loans that need to be repaid, rather than as scholarships or grants that don't. So boosting your financial aid eligibility could just mean getting into more debt.
Meanwhile, it's generally not a good idea to buy life insurance if you don't need life insurance. The policy could wind up costing you a lot more than you'd save on financial aid.
If you're still considering this policy, run the scheme past a fee-only financial planner — one who doesn't stand to benefit financially from the investment — for an objective second opinion.
Spending a windfall wisely
Dear Liz: We received $100,000 from the sale of some undeveloped land. We are trying to figure out the best way to pay off our bills. Our primary residence has a balance of $173,000 at 4.25% and is a 30-year loan. We also own a home we rent out in which we cover the mortgage with the rent income. The balance on it is $131,500 at 4.5% for a 20-year loan. This home is often a burden because tenants change on an average of every one to two years, and we don't have the income to cover the mortgage without the rental income. My husband took a $20,000 loan out of his retirement fund for closing costs for our primary residence, a debt that is being paid back through paycheck deductions. We also have an auto loan with a balance of $7,800 at 2.74% and credit cards at varying interest rates with a total of $22,000 owed. What should we do?
Answer: Your first task should be examining your spending habits to see why you have so much credit card debt. If you don't fix the problem that's causing you to live beyond your means, you're likely to find yourself in a deeper hole eventually, regardless of how well you deploy this windfall.
You also should see if you're on track with retirement savings. Boosting your retirement plan contributions at work and to individual retirement accounts can help you convert this money into long-term economic security.
Next, pay off the credit card debt and consider retiring the retirement plan loan. If your husband lost his job and couldn't repay the debt, the outstanding balance would become a withdrawal that would incur income taxes and penalties.
Any money that's left over can go into an emergency fund to protect against job loss and to keep you from going into debt between tenants. Your low-rate car loans and tax-advantaged mortgage debt aren't top priorities for repayment, but you can start paying them down over time once your other bases are covered.
Questions may be sent to Liz Weston, 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the "Contact" form at asklizweston.com. Distributed by No More Red Inc.