As noted in previous articles and posts, whether or not your student qualifies for federal financial aid for college will depend on the Expected Family Contribution (EFC) calculation.
Typically, almost all assets and income are included in this calculation by financial aid officers. There are exceptions to all rules and in this case, federal aid formulas (under the “Federal Methodology”) exclude home or family farm equity, money accumulated in tax-deferred retirement accounts and cash value built up in a life insurance policy. The cash values of fixed and variable annuities are also excluded.
Since these assets are not counted in determining aid, some families may be tempted to consider “asset shifting” strategies. With such techniques, a countable asset like savings or investments through a brokerage account are used to acquire one or more of these other non-countable asset types.
Friends and clients have attended financial aid workshops sponsored by college aid planners or insurance agents who recommend purchasing annuities or life insurance. Sometimes these strategies involve doing a “cash out” refinance or drawing on a home equity line of credit. Tapping home equity to fund a deposit into an insurance or annuity vehicle may benefit a mortgage banker and insurance agent but is it in your best interests?
Asset Shifting to Qualify for More Financial Aid: Is it worth it?
Well, that depends on what side of the table you’re sitting on.
Yes, it’s true that anything you can do to reduce your expected family contribution may help boost the amount and type of aid your student may receive.
On the other hand, remember these points:
- Family assets are counted at a low contribution rate of 5.6% above the asset-protection allowance calculated for your family circumstances.
- If you put money into a tax-deferred account, it’s locked up. Access to the funds before age 59 1/2 results in early withdrawal penalties in most cases.
- You may have to pay to borrow your own money.
Granted, socking away money into tax-deferred vehicles may make sense for you. And as I’ve noted before, paying for college is as much a retirement problem as anything else so anything you can do to provide for your Golden Years can be a good thing.
But don’t get tempted into long-term commitments to cover short-term financing issues.
By shifting assets you lose access and flexibility for the cash. If employing such a strategy reduces your emergency cash reserve, then you’ve increased your risk to handle unexpected cash needs.
Cash Value Life Insurance and the Bank of You
Cash value life insurance accumulates its value over time. Starting a policy within a couple of years of your student’s college enrollment is not going to help you. During the initial years of such a policy very little cash is built up as insurance expenses and first-year commissions paid out by the insurer to the agent are very high which limit the amount of paid premiums that are actually invested for growth.
But consider this: For some who have existing policies or are looking for a way to build cash over time that offers guarantees and is potentially tax-free, then by all means use life insurance. There are strategies commonly referred to as the Infinite Banking Concept or the Bank of You which champion life insurance as a way to build and access your own pot of money available to you to borrow for almost any purpose.
There are many attributes to life insurance that make these concepts useful
- Tax-free dividends,
- Access to money without credit or income qualifications or delays from a traditional bank,
- Guarantees on the cash value from the insurer.
But one downside is the cash flow needed to actually build up a pot big enough to tap into for buying a car much less paying school tuition. You would in all likelihood need to divert all other available cash and stop funding any other tax-deferred plans to build up the cash. And then there is the time line needed. To effectively build up the cash, you really need to bank on at least 5 years before you have a Bank of You to tap. This is why such a solution is not recommended for those with students about to enter college.
Bottom Line:
Don’t let the financial aid tail wag the retirement planning dog here. Only use these tactics after consultation with a qualified financial professional, preferably one who has no vested interest in whether or not you purchase a particular product.
