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Shelter money from FAFSA - Life Insurance and Annuity - does it work?

rlanghamrlangham Posts: 4Registered User New Member
edited September 2012 in Financial Aid & Scholarships
I am considering using the technique of putting a substantial amount of non-retirement money into a life insurance plan or annuity to shelter some money from FAFSA. I am going through a service and this is something they recommend. Any experiences from people if this really works or not?

One thing I am concerned about are the fees and taxes later on. For example,

1) if do not keep 20% of money in the policy for 10 years then I have a penalty if withdraw from plan.
2) will have 10% penalty for any money taken from plan to pay for student loans (after child graduates) and before I am 59 1/2.
3) Will have capital gain taxes on money withdraw from plan to pay for student loans.
4) Will be paying interest on student loans while they go to school

Thanks
Post edited by rlangham on
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Replies to: Shelter money from FAFSA - Life Insurance and Annuity - does it work?

  • swimcatsmomswimcatsmom Posts: 14,963Registered User Senior Member
    First you need to determine whether you will even be eligible for need based aid if you do tie up your assets this way. If you are not eligible for any aid other than loans then having your money tied up may cost you more in the long run. Remember most non loan federal aid requires a very low EFC (<4617 for the Pell 2009-2010 school year). This requires a low income. Over that the majority of federal aid will be loans.

    The FAFSA EFC is much more driven by income than it is by assets, unless the assets are substantial. There is a certain amount of protected income in the FAFSA EFC calculation based on the number in family ad the number in college. After that the amount of income that goes toward the EFC is from 22% up to 47% at higher income levels (not very high). Assets also have a certain amount of protection based on the number of parents and the age of the older parent. This amount varies from $42,000 for a 2 parent family where the older parent is 40 up to $80,000 where the older parent is 65+. Protection is substantially less for 1 parent families unfortunately. If you have high assets but low income, then for FAFSA the simplified needs test can protect all your assets, This requires income below $50k and meeting other criteria such as being eligible to file a 1040A or 1040ez. If you meet the criteria all assets are ignored. if your income is much over $50k you probably won't qualify for much federal aid other than loans anyway.

    If you are looking at schools that have more generous aid policies with their own institutional funds then they generally require CSS. I don't know how life assurances and annuities are treated by CSS. I am sure someone here will know.

    Personally I would be very cautious of tying up my assets (not that I have enough that they would affect the EFC) in the way you are thinking of. Keep in mind that your service may be making money by selling you a product.
  • rlanghamrlangham Posts: 4Registered User New Member
    Thanks for the detailed reply, this helps. Plus, it reminds me of what additionally they are trying to obtain my sheltering my assets. I do have somewhat higher income, and the current FAFSA estimate is much higher than I would hope or expect or can afford. Sheltering the assets will make little change in this. The college service says that the point in still doing this is in having the college possibly provide other aid that they normally may not do if they saw your total liquid assets. As they explain, college does run like a business. Possibly in some negotiations with the aid office you may get more using this technique than normally would.
  • swimcatsmomswimcatsmom Posts: 14,963Registered User Senior Member
    FAFSA only schools will base aid on the FAFSA EFC. As far as I know they don't vary the aid because xxx of the EFC is generated from liquid assets as opposed to from income. If sheltering the assets is not actually going to make much change to the EFC then I would be surprised if it would lead to more aid. Remember a lot of FAFSA only schools do not have a lot of their own institutional money to give out as aid. And if the aid ends up being all in loan form will this make having your assets tied up beneficial?

    Honestly to me it all sounds very dubious. I should add the caveat that I personally am very suspicious of people who try and sell me on the whole idea of tying assets up in annuities and life insurances. We have had people try and sell us this sort of product in the past and at that point we stop listening and just stay as short a time as possible and leave, never to return.
  • thumper1thumper1 Posts: 36,200Registered User Senior Member
    I do have somewhat higher income, and the current FAFSA estimate is much higher than I would hope or expect or can afford. Sheltering the assets will make little change in this.

    The bulk of your EFC per FAFSA is determined by your income, not your assets...unless you have incredibly high assets. There is an asset protection formula (which varies depending on a number of factors). Beyond the protected amount, your assets are assessed at 5.6%. On $100,000 of assets, that is $5600. Obviously, if you have very extensive assets, this amount would be higher.

    My question always is this...why not use some of those assets to help fund your child's education? You are fortunate enough to have saved, what sounds like, a considerable amount that is in liquid assets. If that is the case, why not USE some of that for your kid's college education? You wouldn't be using all of it...only 5.6%...which really isn't a lot.

    And as mentioned, this ties up these liquid assets so that if you want to use them for some other purpose, you won't be able to.

    Has your "service" suggested maxing out your retirement contributions? Starting an IRA and/or Roth IRA?
  • hmom5hmom5 Posts: 10,882- Senior Member
    Your service sounds suspect. You already answered your own questions in your first post. Do you really want to tie up your money and face the future taxes to hopefully 'negotiate' for better aid when you have a high EFC?

    These services are a joke.
  • notrichenoughnotrichenough Posts: 5,465Registered User Senior Member
    If you do decide to do this, look around at other companies' products as well. The "service" you are using is undoubtedly making *substantial* commissions on the sale of these products, and selling these annuities may actually be the primary goal of the business. The withdrawal penalties sound high. The 10% penalty before age 59 - who is charging this penalty? This is typical for IRA's and other tax-advantaged retirement savings vehicles, but for non-retirement assets, sounds ridiculous.

    How much are you talking about? Is it going to be worth the 5%+ haircut you will take on the commission?
  • rlanghamrlangham Posts: 4Registered User New Member
    Lots of great replies, very helpful. First kid going to college, so kinda overwhelmed at this time :) To answer a few points...

    1) The money would be going into a MEC (modified endownment contract) life insurance policy which has IRS requirements similar to IRAs. I am thinking the 10% penalty is only on the gains from the money. But, I believe any money withdrawn for it would be from the gains first, then from the cost basis.

    2) I can take money out at any time for only $25 fee. I only get charged additional fees by the policy if I remove more than 80% by 10 years. So, I do have pretty easy access to the money for emergency purposes.

    3) I am choosing one of their investment plans that I am guaranteed not to lose any money (due to stock market downturn), and can actually make up to 40% higher than a stock market index fund, but limited by a cap if market does very good. So, sorta interested in just the investment since the money would be safe. Again, I think I can access the cost basis up to 80% without the 10% IRS penalty (after the gains).

    4) I plan to use a lot of it for college expenses, but do not want to spend all my savings either. They suggest can get better colleges rates using this method and use student loans, then once child is out then ideally pay for all the student loans. During the school years, make regular deposits to MEC in order to let it build up. I think would plan on paying the interest on student loans in order to keep them from building too high.

    They are a reputable U.S. company that has been around for 15 years and A+ BBB rating and can't find anything negative about them through a lot of research. At the very least, the life policy seems like a decent investment method and get some needed additional life insurance. I will be 59 in 10 years and have 2 kids due for college. Just didn't know if really a college would give you additional cuts on rates using this method. Sorta doubting this now :)

    5) I am dumping so more money in IRAs, but I guess there are some limits here.

    Going to find out now the real cost of the life insurance. e.g. percentage, etc. and compare.

    Thanks again.
  • happymomof1happymomof1 Posts: 19,212Registered User Senior Member
    The other thing that you do need to consider is that it is indeed OK for you as a parent to say to your children "FAFSA indicates that we can pay $xx for your education. In fact, we can only pay $xx-yy each year. Here is a list of colleges and universities that are within our budget. If you want to go anywhere else, you will need to look for scholarships that will bring our family cost down to $xx-yy." Nationwide, many (if not most) families tell their children something like that.

    I did. Happykid looked at the numbers and said, "Fine with me." She's headed to the school that we can truly afford.
  • LasMaLasMa Posts: 7,702Registered User Senior Member
    OP: swimcatsmom is correct about CSS PROFILE, which is another financial aid form required by many of the most generous private colleges (this is in addition to FAFSA, which is universally required). PROFILE is far more detailed than FAFSA, and delves deeply into assets as well as income.

    Just glancing at our PROFILE from last year, I noticed that it asks for the following (among pages and pages of other data):
    * Do you have "a civil service or state sponsored retirement plan"? It also asks about military, union, and employer retirement plans.
    * "Total current value of tax-deferred retirement, pension, annuity, and savings plans. Include IRA, SRA Keogh, SEP, 401(k), 403(b), 408, 457, 501(c) plans, etc."
    * "The amount of deductible IRA and/or SEP, SIMPLE, or Keough payments" you made or will make.
    * "The amount of payments to tax-deferred pension and savings plans" you made or will make.

    Let me hasten to say that I'm no expert on these things, so I don't know if any of the above would apply to what you're proposing. Our situation is alot simpler, and I don't even understand all of those terms! But if you're looking at the universe of PROFILE schools, I just want to make sure you're aware that you may in the end be required to disclose some of the assets you're trying to shelter.

    Also note that just because PROFILE requires a piece of info, doesn't mean that any given school will even care. PROFILE is a one-size-fits-all report which is intended to provide a complete picture of your financial situation. Colleges then look at the parts of the report which are used in their particular formulas.
  • ebeeeeeebeeeee Posts: 5,199Registered User Senior Member
    Grr..we are spending almost all of our savings (non retirement that is) on our two kids college education. We made a promise to each other before they were born that we would pay for their undergrad education with no loans and we are sticking to that promise. We began saving when they were born.
    If the money wasn't for tuition what would we be sheltering it for? Another nice car? A house bigger than we need?
    These questions always come up on this board and I always hate them.
    Go ahead, shelter your money. Let your kids take out loans. (at least a third of the FA will be in loans) If something drastic happens in your family your money won't be liquid. Good luck.
  • ebeeeeeebeeeee Posts: 5,199Registered User Senior Member
    Just reread the OP's last post and wanted to add: you are taking a BIG risk. You talk about taking loans and paying the interest so they don't get too high. If something happens and you have to take the money out of these accounts early you are looking at paying a ten percent penalty to get your own money back. In the meantime, do you know what the loan rate is on the student loans? How does it compare with any interest you would get on the insurance account? I will bet you will find the interest of the loans is higher than the interest you get on the insurance account. So you are paying to "hide" your own money. Dumb strategy in my book.
  • scottaascottaa Posts: 1,037Registered User Senior Member
    I have a great deal of experience in putting these plans together for families. Here's my take...

    Sheltering does work, WHERE APPROPRIATE. I have rarely seen a case where sheltering parental assets into a life policy made a substantial difference. It does happen but it is rare. Student assets are another matter. Sheltering student assets is typically a no-brainer.

    If sheltering the assets does not have a substantial impact on your EFC, it's not worth it.

    I do not know what the adviser means by "get better colleges rates". Again, if it does not impact your EFC, there's not much point.

    Without naming the product, I'm hesitant to offer a definitive opinion, but I'm leary of the specifics you've described of the policy. I'm guessing there are better products out there.
  • thumper1thumper1 Posts: 36,200Registered User Senior Member
    They suggest can get better colleges rates using this method and use student loans, then once child is out then ideally pay for all the student loans.

    I think you need to run your figures though an EFC calculator and see for yourself if there is a difference...OR NOT...Use the institutional methodology.

    As stated...EFC is largely based on your INCOME...not your assets. So...if your income is on the high side, sheltering your money as your "service" suggests will likely benefit you NOT AT ALL.

    In addition, you don't mention the types of colleges on your radar screen. If your kiddo applies to a FAFSA only school, that school will not likely guarantee to meet your full need anyway. There will be a gap between what they award you and what you can pay. If you "shelter" your money...what will you use to pay that gap?

    I think you need to get a second opinion from a different "service". If you have VERY significant assets...say in the millions of dollars...then this could impact your expected family contributions per FAFSA and Profile...but if you are talking even a lot less than that...I'm not sure I would see the advantage. AND personally, I think if you have liquid assets in the million dollar range, using 5.6% of those assets to help your kid through college isn't asking a lot. I'm not a financial planner or tax expert or anything of this kind...but I certainly would be getting a second opinion regarding where my money will be. I do this EVERY TIME I reapportion my retirement contributions. I certainly would do so if I were planning to tie up my liquid assets in any significant way.
  • rlanghamrlangham Posts: 4Registered User New Member
    Nothing like a million. Otherwise, wouldn't be an issue :) More like $100K +/-. I have another kid a couple of years away.

    It is primarily FAFSA only schools and primarily public, a couple of private. The service says that using this method that you can sometimes get a private school to offer more aid money to compete with public rates.

    I think I am seriously reconsidering not going this route, I am talking to the person tomorrow.
  • Dad_of_3Dad_of_3 Posts: 1,828Registered User Senior Member
    Life insurance and annuities have always been controversial in any financial discussions I've had. I don't know if the people who are against them have vested interests, or if they have a 2007 pre-economic-tsunami worldview, or whether their points are really true.

    Examples of points that people bring up are:
    - Life insurance as an investment is too costly so only buy term insurance for the specific insurance need and with the difference buy investments that would overall give a better return.

    - Non inflation-adjusted annuities have a risk of that the payout will be insufficient when it happens, while inflation-adjusted ones have very high premiums.
    etc.
    I don't have enough expertise to comment how valid these are, but a lot of people I deal with don't particularly care for them. In reality I suspect they are just instruments that are "fits" for some and not for others.
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