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Motley Fool Answers' August Mailbag: Is Variable Universal Life Insurance a Good Tool to Save for College?

By Motley Fool Staff - Sep 6, 2018 at 12:38PM

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If you have kids, you need life insurance, and you need to put money aside for their higher education. What you don't need to do is combine those tasks.

Summer is just about over, but we expect most Motley Fool Answers listeners didn't "sell in May and go away" -- you've been keeping up with matters of finance and investing all along...right?

However, if you happened to take a break from thinking about your money during beach season, you might have missed a few of Alison Southwick and Robert Brokamp's monthly mailbag shows. In which case, you wouldn't have noticed that Ross Anderson -- certified financial planner from Motley Fool Wealth Management, a sister company of The Motley Fool, and a regular on the mailbag podcasts this spring -- took a break from his guest hosting duties as well, so that other Fools could get their time in the sun. Now, he's back to help the podcasting duo address another batch of listener queries.

In this segment, new father Guarav is thinking long term: He wants to invest for his infant daughter's college needs. But instead of the obvious choice of a 529 plan, someone is advising him to use a variable universal life insurance policy as his "investment" vehicle instead. (Someone, perhaps, who gets a sweet commission from selling such policies? Not 100% clear, but the Fools have their suspicions.) Here's a simple breakdown of why VUL policies are not quite as advantageous as insurance salespeople may make them appear, and a better strategy for parents to address these two unrelated financial planning needs.

A full transcript follows the video.

This video was recorded on Aug. 28, 2018.

Alison Southwick: The next question comes to us from Guarav. "I'm 33 years old and have a two-month-old daughter. Could you please share your thoughts on variable universal life insurance? It has been recommended to me that I should buy a VUL policy rather than contribute to a 529, since the money from the policy can be used for any needs that come up. I've tried to research VULs, but I can't find a simple-enough explanation on the logistics of it."

Ross Anderson: I think that he's probably been talking to an insurance salesman. Very few other people are going to be talking about the benefits of the VUL product like that. This is two things kind of matched together. You've got a life insurance policy and you've got an investing account that's attached to it. And the way that it's supposed to work is that let's say your cost of insurance -- so that you can protect your income and future livelihood -- is $50 a month. But instead of paying $50 a month, you're going to pay $250 a month, and that extra $200 is going to go into this account. It's going to become invested and it's going to do wonderful things for you.

The way that they're sold is often talking about two benefits. One is that the withdrawals are going to be tax-free and what they're really saying is that you can take a loan against the money that's accumulating in this policy and that that will be tax-free. Now, that's kind of a "gotcha" because no loans are taxable. You don't take a mortgage out on your house and then pay taxes on the loan, so that's always an interesting little spot that insurance folks like to talk about. But the other problem with those is that if you don't have a lot of money in that side account that's accumulated, you can actually put the insurance at risk when you start to take some of that money out.

My preference is if it's an investment, treat it like an investment. If you need insurance treat it like insurance. I think you're much better off if you need insurance looking at a term life policy that is low cost, very straightforward, and then continuing to save into another vehicle. Now whether that's the 529 or if you just want to save into a taxable brokerage account -- if having that flexibility is really important to you -- you don't have to use the 529. You do get a tax benefit because it is meant for education and that now includes some free higher education. So you can use that money now toward some expenses before college, even. So the 529 has gotten a little bit more flexible. I very much don't like the idea of VUL or variable life policy for education funding. I don't think it's the best tool for that.

Robert Brokamp: First of all, I think he's doing two very important and smart things. He's looking at life insurance, which is what you should do once you have a kid and looking at saving for college. Good for you for doing that! The benefit of the 529, of course, is that the money comes out of the account tax-free if you use it for qualified expenses. What the insurance salesman might be saying is, "Well, if you need it for something else, you're going to have to pay taxes and penalties." That's actually only on the growth. Any money that you put in yourself you get to take out tax and penalty free. So it's not as bad as some people say. And, if for some reason, your daughter doesn't go to college, it can always be transferred to other relatives, yourself included, if you want to go back to school later. It's actually got a lot of flexibility to it.

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