How life insurance can help pay for a child’s education

I’ve got two kids attending university this fall. Our oldest son will be living off-campus in an apartment that can only be described politely, based on its odour, as objectionable. My wife thinks it’s even more concerning that he doesn’t seem to care. I told her: “Carolyn, young men are a species that are happy to wear wrinkled clothing lying on the floor if it isn’t walking itself to the laundry room. You think they care about the look and smell of their living quarters?” Despite the condition of the place, I can attest to how expensive the rent is every month. Add the cost of tuition, books, food and transportation, and it can make for a very expensive four years.

Today, I want to share an idea that can help to cover the cost of a postsecondary education for that child in your life. This idea comes with a ton of flexibility so that the savings could be used for other purposes as well.

The idea

Most people think of life insurance as a costly, but sometimes necessary, expenditure. It’s rarely considered an investment. It’s unfortunate, because life insurance has some important attributes that can make it an effective financial tool. For starters, investments inside a permanent life insurance policy can grow on a tax-sheltered basis.

If you choose to insure the life of a child or grandchild, the cost of the insurance will be low, and the savings accumulated over the years can be used to help pay for an education, among other things.

Consider these numbers: If you were to contribute $216 each month to a participating whole life insurance policy on the life of your child, starting from their first year of life, you will have accumulated $70,023 (the cash value of the policy) in 20 years (assuming a current dividend scale of 6.35 per cent annually). These funds could be used to help pay the cost of an education. Alternatively, the funds could continue to accumulate in the policy and would be worth $135,994 at the age of 30 (this could make a helpful down payment on a home), $249,979 at 40 (perhaps to help start a business), and $990,023 at 65 (perhaps to help your child meet costs of retirement).

Sure, you always need to compare an investment like this to the alternatives – most notably a registered education savings plan (RESP). If you were to invest the same $216 each month in an RESP for 20 years, collect the maximum Canada Education Savings Grants (CESGs) along the way (equal to 20 per cent of RESP contributions to a maximum of $7,200 for each student), and chose investments that are of the same risk level as the whole life insurance policy (fixed income risk), you’d end up with about $95,150 in the RESP after 20 years (assumes an average rate of return of 4 per cent).

So, why not choose the RESP instead? Make no mistake, an RESP is an effective way to save for a child’s education. But the savings must be used for a single purpose: the education of the student (otherwise, taxes, penalties, and/or repayment of the CESGs could result).

The nuances

There are other nuances that could make the insurance policy a great option:

•  The figures above assume that there are no more insurance premiums paid after 20 years.
•  The funds in the insurance policy can be accessed in a number of ways: Receive the annual dividends on the policy as cash payments, borrow from the cash value of the policy, withdraw the investments in the accumulating fund, cancel the policy and withdraw the cash value, or borrow up to 90 per cent of the cash value from a bank. Each method has its own tax implications.
•  You can transfer ownership of the insurance policy to your child or grandchild on a tax-free basis once they’ve reached the age of 18. This will result in a transfer of the assets inside the policy, tax-free, and free of the attribution rules that might have otherwise applied to income earned while the kids were minors.
•  If you have the means, you might consider buying an annuity today to provide the cash annually to pay the insurance premiums for this strategy. This is truly a “set it and forget it” idea. The cost of the annuity could be less than the cost of paying the premiums annually out of other cash flow.

Thanks to Michael Lampel of insuranceforchildren.ca for providing the figures here and providing a reminder as to the type of financial planning possible for children using insurance.

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at tim@ourfamilyoffice.ca.