Help your kids and grandkids avoid college debt

As higher education costs continue to rise, it is important to consider how best to fund your child’s or grandchild’s education.

I propose a multi-pronged approach to use tax-advantaged 529 plans, trusts and term life insurance.

The 529 plan offers great long-term savings capability, but in the event of a worst-case scenario, a trust with life insurance funding provides a safety net.

Let’s start with a young couple with young children.

Assume that couple has limited resources proportional to their age and new family support obligations. That young couple is also smart and wants to plan to take care of their children’s anticipated (and ever-increasing) college tuition.

Start with a 529

The 529 plan is a state-sponsored tax-advantaged investment account. The parents make contributions to the 529 plan that can both grow tax-free and be distributed from the account to pay qualified educational expenses free from federal income tax as well.

The 529 account contributions are generally invested in an investment account, a diversified portfolio of stocks and bonds, mutual funds, or Exchange Traded Funds. This is an excellent choice to begin saving for college for the children.

But, the young couple probably anticipates contributing a smaller amount over their children’s early life (think, for example, an 18-year funding plan). That means that, at least early on, there will not be enough assets in the 529 plan to pay for college and the child may have to secure scholarships or loans to pay the difference.

To plan for the worst-case scenario of a premature death of the parents, the couple should consider a safety net that a trust combined with term life insurance can provide their children.

Add a trust

The young couple would next want to update or establish their estate plan and get a new will.

The will provides that if the parents pass away, their assets will be held in a trust for the children. The terms of the trust will generally provide that the trust assets are used to provide educational opportunities to the children as well as providing basic housing, transportation, food expenses and other costs.

The difference here is that the 529 plan is funded using current contributions while the trust would be funded using any other assets the parents might have – assets like a house or car.

Of course, this trust would only come into existence and be funded with the proceeds from the sale of the house or the couple’s car in the unfortunate event of their premature death. But, this would provide additional resources to help provide the funds necessary to pay for the children’s education where the 529 assets were insufficient.

In many circumstances, the total assets owned by the couple might still not be enough. Perhaps they just bought the house and have little equity. Perhaps the cars or other assets aren’t worth much either.

The couple could then consider using term life insurance to provide adequate funding for the trust.

Buy term life insurance

To make sure that there are enough assets to properly fund the trust, the couple would shop for, and acquire, a term life insurance policy.

Like all life insurance policies, it pays out an amount of money upon the death of the insured person(s) – in this case, one or both parents.

Term life insurance is usually cheap to acquire, especially in this case where the proposed insured couple is young (and commensurately healthy). By way of example, perhaps the couple decides in the first step above that they can fully fund the 529 plan in 15 years.

Well, then maybe they decide to purchase a 10-year term life insurance policy to provide the funding shortfall if they don’t survive to be able to make all the contributions to the 529 plan.

Of course, the parents would want to have life insurance to provide coverage not only for college education but also for the costs of raising the children and other costs outside of education should they suffer a premature death.

Those considerations are for another article. Suffice it to say that a larger term life insurance policy can go a long way in offering the funding to take care of the couple’s children in a variety of circumstances.

The grandparents

This column has focused on the young couple so far, but grandparents have options as well.

They too can contribute to the same 529 plans. And they probably are in a better place financially.

The law allows them to contribute up to five years’ worth of annual gifting to each child’s 529 account ($75,000) and elect to report it proportionately on each of the subsequent five years ($15,000 per year in this example).

Grandparents too can divert some or all their assets into trusts for their grandchildren’s education, just like the parents can. However, life insurance generally stops making as much sense for the grandparents as a funding tool for their grandchildren’s education so the grandparents would instead rely upon the current estate value.

Beau Ruff, a licensed attorney, is the director of planning at Cornerstone Wealth Strategies, a full-service independent investment management and financial planning firm in Kennewick.


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