THE BAIT: "YOU WILL EARN A GUARANTEED RETURN"
As some agents tell it, cash value insurance does sound like an ideal investment for college savers. Combining a death benefit and a savings account, the policies offer guaranteed returns, recently around 4% for whole life and at least 2% for indexed universal life policies that can reap additional gains in the stock market.
Investing via monthly premiums (recommended for parents of younger children) or one lump sum (among the few options for parents facing imminent college bills), you build cash value over time. Then you can borrow tax-free against the standard policy later, or withdraw money from a single-premium policy to pay college costs. An annuity offers similar advantages but no death benefit.
The trouble is, it takes years for these policies to build to their guaranteed return; in the early years, high commissions (often 8%) and the cost of the death benefit eat into cash value.
The half dozen college-oriented life insurance policies analyzed by MONEY generally took at least seven years to earn their promised returns. Yet about 25% of whole life policies lapse within five years because people can't keep up the premiums. A policy with an initial cash value of $4,000 that builds to $140,000 in 10 years and a $300,000 death benefit might run you $1,000 a month.
Single-premium policies have other wrinkles. To come up with the lump sum to invest, agents often urge parents to move money out of other assets, such as a 529 savings plan.
That can be costly; if you take profits out of a 529 and don't immediately use the money for college, you'll pay taxes and a 10% penalty. You also can't borrow from single-premium policies or take money out tax-free; plus, parents under age 59½ will pay a 10% penalty on any gains they withdraw.
Worst of all, tapping the policy to pay college bills could hurt future aid because the withdrawals can be treated as taxable income.
The complications and gotchas can turn life insurance and annuities into an expensive mistake for some parents.
Ask Suzette Shilts, a school aide from Hingham, Mass., who in 2010 found herself "in a panic" about how to pay looming college bills for her high-school-age daughter and son. So she went to local planner Kirk Brown, owner of the College Advisors Group, for help. He suggested putting her savings in a guaranteed annuity, which Shilts did. But months later, when she needed the money for a family emergency, she discovered she would lose $1,700 to early-surrender charges. "I thought I was doing the right thing, and it turned around to bite me," she says now.
Brown, who in 2009 agreed to a $245,000 fine to settle state civil charges that he placed several college families in inappropriate insurance policies, says Shilts told him the money was earmarked for retirement, not college -- even though he prepared an eight-page college funding report for her that Shilts showed to MONEY. Brown also notes that Shilts "signed off on all the disclaimer sheets" and that an annuity is a good choice for long-term savings.
How to avoid the trap
Get a second opinion. Don't make a big move like sinking your savings into life insurance without running it by an independent consultant. For $100, for instance, EvaluateLifeInsurance.org, headed by the former insurance commissioner of Vermont, will analyze any life insurance proposal.
Look at other providers. At MONEY's request, insurance consultant Glenn Daily evaluated policies from many of the biggest players in the college market, including Lafayette, MTL, Aviva, and North American.
While the products provided higher-than-average cash values, Daily says, they were complicated and didn't fully disclose true costs -- a common problem. He says parents would do better with a no-commission policy from TIAA-CREF or ones from top-rated mutual insurance companies such as Mass Mutual or Northwestern.
THE BAIT: "COME TO MY FREE COLLEGE FUNDING WORKSHOP"
Once your kid hits 11th grade, you're likely to start getting invitations to free college funding workshops, often held at a local high school and sponsored by a nonprofit. Beware.
Like the free-lunch seminars that some retirement planners use to lure seniors to invest with them, these supposedly no-pressure informational gatherings often turn out to be a thin cover for insurance agents looking to drum up business.
Consider insurance agent Nancy Ziering, who runs a planning business called College and Retirement Solutions in Chatham, N.J. Last spring Ziering gave free college seminars at several high schools, claiming to represent the Education Funding Consultants Association, a nonprofit.
In a recent blog post on the website of Coastal Producers Group, another college financial planning company that she is affiliated with, Ziering encouraged agents to hold a "Free College Financial Aid Night," at schools to win new clients. She wrote, "It would be in your best interest to be affiliated with our nonprofit, as many schools will not allow for-profit businesses access to parents and students." What Ziering didn't disclose was that EFCA had lost nonprofit status years before for failure to file tax forms.
Ziering also happens to be one of the few college planners who has been the subject of disciplinary action. In 2008 she was suspended for nine months and fined $60,000 by the Financial Industry Regulatory Authority after settling charges from at least six clients that she had sold them inappropriate variable universal life policies.
Ziering says she has since stopped recommending the questionable policies. Last fall, however, the New Jersey department of banking and insurance initiated proceedings to strip Ziering of her insurance license, contending that she put at least 15 clients into inappropriate insurance policies. Ziering, who denies any wrongdoing, is awaiting a hearing date.
Imprisoned planner Linda Taylor says she also used a nonprofit to gain access to schools and claims it is common practice. Many advisers follow a formula, she says: "They buy a list of names of families. They send out postcards offering free college funding seminars, they do the seminar, they scare the s--- out of parents and then offer them hope."
NACFA training videos obtained by MONEY seem to follow this approach. In them, session leaders suggest that advisers use questions and information to lead parents into what the late marketing guru David Sandler coined a "pain funnel" to increase their desire to pay for relief.
Sandler's techniques are used by salespeople of all types. To sharpen the pain, some college funding advisers emphasize how complex the financial aid process is. Others warn that colleges can take all your savings, 529 plans have had big losses, or that Washington budget cutters will eliminate their tax breaks.
Says Taylor: "Parents come in, their kid is a year away from college, and they are panicked. They will believe anything."
What to do
Resist the hard sell. Dire proclamations should set off alarm bells.
Despite a few rough years during the financial crisis, 529 plans usually work out better than life insurance for college savers. And tax breaks for 529s are not scheduled to lapse in the fiscal cliff. If you don't waste effort on shortcuts that may not work out and instead just save steadily and, when the time comes, favor affordable schools, you can pay for college without turning into a pauper -- or an ELF.
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