College Tuition and Participating Whole Life Insurance

The rising cost of higher education has become a financial burden for many American families. According to the Education Data Initiative, the average cost of in-state college tuition has increased dramatically, making a 4-year college degree almost 40 times more expensive than it was in 1963. When considering private universities, out-of-state tuition, or prestigious Ivy League institutions, the financial commitment grows even more.

For parents concerned about funding their children’s education while maintaining financial flexibility, participating whole life insurance presents a compelling alternative to traditional college savings vehicles. Let’s explore how this approach works and why it might be worth considering for your family’s educational funding strategy.

The Challenge of College Funding

When it comes to financing higher education, most families face a difficult decision. Traditional college savings options like 529 plans offer tax advantages for educational expenses but come with restrictions. If funds aren’t used for qualified educational purposes, withdrawals may be subject to taxes and penalties. These accounts provide little flexibility if your child decides not to pursue higher education or receives substantial scholarships.

This predicament is exactly what Dave and Rebecca, both successful Ivy League graduates each earning over $250,000 annually, faced when planning for their daughter Laura’s future education.

An Alternative Approach: Participating Whole Life Insurance

After reading “The Richest Man in Babylon” at their insurance agent’s suggestion, Dave and Rebecca gained clarity about the value of participating whole life insurance as a wealth-building tool. The book’s main principle—saving at least 10% of all earnings in liquid assets that can be leveraged when needed without sacrificing growth—resonated with them.

While Dave and Rebecca hoped Laura would attend Stanford University, they were hesitant to commit funds to a 529 plan given the uncertainty of her future educational choices. Instead, they decided to purchase a participating whole life insurance policy on Laura’s life, allocating $20,000 annually (4% of their combined income) toward premiums. The remaining 6% of their targeted savings would cover Laura’s private schooling, tutoring, and extracurricular activities before college.

How the Policy Performed

By the time Laura turned 17, her participating whole life insurance policy had accumulated $454,541 in cash value. This growth occurred despite a reduction in premium payments during her last two years before college—from $20,000 to $16,748 annually—to prevent the policy from becoming a tax liability under IRS guidelines.

When Laura was accepted to Stanford, Dave and Rebecca’s insurance agent outlined a plan to finance her education:

1. Borrow $90,000 annually from Laura’s policy to cover the $83,000 in annual expenses for tuition, books, room and board, with a $7,000 buffer for unexpected costs
2. Continue paying reduced premiums of $5,583 toward Laura’s policy during her four years of college
3. After graduation, gift the policy to Laura, who could continue paying $20,000 annually to repay the policy loans while building cash value

The Financial Advantages of This Strategy

This approach offered several benefits:

1. Loan Repayment Efficiency: Ten years after Laura’s graduation, the $360,000 borrowed for her education would be fully recovered, with her policy showing $1,337 more in cash value than when she began college. While Dave and Rebecca spent $360,000 on her education, Laura would only need to pay $200,000 over ten years to recover that amount— reducing her “student loan” costs by 44.44%.
2. Long-Term Growth: By age 65, Laura’s policy would accumulate about $3,250,369 in cash value. All of this could be accessed tax-free during retirement while preserving a $3,000,000 death benefit for her heirs.
3. Financial Comparison: If Laura had financed her education through traditional student loans at 4% interest over ten years, repaying $360,000 would have cost her $43,738 annually, totaling $437,379. Instead, by repaying her policy loan at $20,000 annually, she saves while recouping the $360,000, resulting in a net advantage of $361,337.
4. Lifetime Return on Investment: In total, Laura will have paid $860,000 into her policy by age 65 but will have $3,250,369 in accessible cash value. To achieve comparable results through traditional investments, she would have needed consistent annual returns of approximately 11.897% on her $20,000 contributions. If these investments weren’t tax-deferred, the required return would be even higher—closer to 13-14%.
5. Death Benefit Preservation: Unlike traditional investments that may be depleted during retirement, the participating whole life insurance policy allows Laura to access her cash value while providing a death benefit to her heirs, tax-free.

Flexibility – The Hidden Advantage

Another valuable aspect of using participating whole life insurance for education funding is its inherent flexibility. Unlike education-specific savings vehicles, the cash value in a participating whole life policy can be used for any purpose without tax penalties. This provides options if educational plans change:

1. Option for Parents: After borrowing $360,000 for Laura’s education, Dave and Rebecca could stop premium payments and keep the policy for themselves. By age 70, they could surrender the policy and receive $190,000 (though they would owe income tax on amounts exceeding their total premium payments).
2. Option for Laura: If gifted the policy after college, Laura could choose to surrender it and walk away with over $100,000 in surrender value (after applicable taxes).
3. Continuous Leveraging: Dave and Rebecca could retain the policy, repay the loans, and continue using the cash value to finance other expenses throughout their lives, recovering money that would otherwise be spent.

This flexibility stands in stark contrast to 529 plans, where funds have to be used for qualified educational expenses to avoid taxes and penalties.

Understanding Cash Value and Policy Loans

To grasp the benefits of this strategy, it’s important to understand how cash value and policy loans function in participating whole life insurance:

Cash Value Growth

In a participating whole life insurance policy, a portion of each premium payment contributes to the policy’s cash value, which grows tax-deferred through:

1. Guaranteed Interest: The insurance company guarantees a minimum interest rate on the cash value.
2. Dividends: As a participating policy, it’s eligible to receive dividends when the insurance company performs well financially. These dividends, while not guaranteed, have historically been paid by established mutual insurance companies for decades, even through economic downturns.

The combination of guaranteed growth and potential dividends creates a stable, predictable asset that grows regardless of market conditions.

Policy Loans

When you take a loan against your policy:

1. The insurance company lends you money using your cash value as collateral.
2. The full cash value in your policy grows as if you hadn’t borrowed anything. This is an important distinction from other financial products where withdrawals directly reduce the principal that earns returns.
3. You pay interest on the loan (typically at rates competitive with or better than commercial loans), but the policy earns interest and potential dividends on the full cash value.
4. If you don’t repay the loan during your lifetime, the outstanding balance is deducted from the death benefit when paid to your beneficiaries.

This mechanism allows you to access liquidity while maintaining the growth of your asset—a powerful financial tool.

Real-World Application vs. Traditional Approaches

To put this strategy in perspective, let’s compare it to traditional approaches for funding college education:

1. Self-Funding (Paying from Current Income)

For many families, paying college expenses from current income is challenging or impossible. Even high-earning households like Dave and Rebecca’s might struggle to allocate $83,000 annually for four years without lifestyle adjustments.

2. Traditional Student Loans

Federal and private student loans usually charge interest from the moment funds are disbursed, with repayment beginning shortly after graduation. Using our example:

• $360,000 in student loans at 4% interest over 10 years would require payments of $3,645 monthly ($43,738 annually)
• Total repayment: $437,379
• Net result: -$437,379 (money paid out with no asset remaining)

3. 529 College Savings Plan

If Dave and Rebecca had invested $20,000 annually in a 529 plan instead:

• They might have accumulated a similar amount by Laura’s college years (depending on investment performance)
• The funds would be tax-free if used for qualified educational expenses
• Any unused funds withdrawn for non-educational purposes would incur taxes and potentially a 10% penalty
• Once spent, the money is gone—no future growth potential

4. Participating Whole Life Insurance Approach

As outlined above:

• Total parental outlay before college: $355,828
• Education costs funded: $360,000
• Laura’s cost to repay policy loans: $200,000 (over 10 years)
• Laura’s policy value at age 65: $3,250,369 (plus $3,000,000 death benefit)
• Net lifetime advantage: Millions of dollars in accessible cash value plus a substantial legacy for heirs

The contrast in long-term outcomes highlights why this approach deserves consideration, especially for families with the discipline to maintain premium payments and loan repayments.

Important Considerations for Implementation

While the benefits of using participating whole life insurance for college funding are compelling, successful implementation requires attention to several factors:

1. Policy Design Matters

Not all whole life insurance policies are created equal. The structure of the policy impacts how quickly cash value accumulates and how efficiently it can be accessed:

• Premium Allocation: A properly designed policy maximizes the portion of premiums allocated to cash value growth through paid-up additions riders
• Dividend Options: How dividends are directed within the policy affects long-term performance
• Insurance Company Selection: Mutual insurance companies (owned by policyholders rather than shareholders) typically offer more favorable participating policies

Working with an agent experienced in designing policies specifically for this strategy is essential.

2. Timing Considerations

Ideally, a policy should be established early in a child’s life to maximize cash value accumulation before college expenses begin. Starting a policy when a child is a newborn or toddler provides 15+ years of growth, enhancing the strategy’s effectiveness.

3. Health and Insurability

Since the policy is based on the child’s life, their insurability is a consideration. Fortunately, children usually qualify for preferred rates, and smaller policies require minimal underwriting.

4. Disciplined Management

The success of this strategy depends on consistent premium payments and disciplined loan repayment. Without this commitment, the projected benefits may not materialize.

5. Tax Implications

While cash value growth is tax-deferred and policy loans are not taxable events, there are IRS guidelines regarding premium payments and policy structure that must be followed to maintain tax advantages. Properly structured policies avoid becoming Modified Endowment Contracts (MECs), which would alter their tax treatment.

Beyond College

What makes participating whole life insurance valuable as a college funding vehicle is that it serves multiple financial purposes beyond education:

1. Financial Safety Net

The death benefit provides financial protection for the family throughout the child’s developmental years.

2. Emergency Fund

The accessible cash value serves as a liquid emergency fund that can be tapped for any purpose at any time.

3. Future Major Purchases

Beyond college, the same policy can be leveraged for other major expenses like a wedding, home purchase, or business startup capital.

4. Retirement Supplement

As demonstrated in Laura’s case, the long-term cash value growth creates a tax-advantaged asset for retirement income.

5. Estate Planning Tool

The death benefit passes to beneficiaries income-tax-free, creating an efficient legacy transfer mechanism.

This multifunctionality provides tremendous value compared to single-purpose educational savings accounts.

Is This Strategy Right for Your Family?

While the case study presented here involves high-income professionals, variations of this strategy can be adapted for different income levels and financial circumstances. Key considerations include:

• Your ability to consistently allocate funds to premium payments
• The timeframe before your child will need educational funding
• Your desire for flexibility in how educational funds might ultimately be used
• Your interest in building a multi-generational financial asset

Families with more modest incomes might implement smaller policies with lower premium commitments while still benefiting from the mechanics and advantages of the strategy.

As the cost of higher education outpaces inflation, traditional funding approaches may leave families with limited options and financial constraints. Participating whole life insurance offers a promising alternative that combines educational funding with long-term wealth building and financial flexibility.

In the case of Dave, Rebecca, and Laura, we see how this approach not only funded a prestigious university education but also created a financial asset that will serve Laura throughout her lifetime and beyond. The strategy transformed what would have been an expense (college tuition) into an investment that grows and provides benefits for decades.

For parents concerned about the rising cost of education who value financial flexibility and long-term wealth creation, participating whole life insurance deserves serious consideration as part of a college funding strategy. By working with knowledgeable professionals who understand how to properly structure these policies, families can create educational funding solutions that align with their financial goals.

The true value of this approach lies not just in paying for college, but in doing so in a way that builds rather than depletes family wealth—turning one of life’s largest expenses into a cornerstone of long-term financial prosperity.

Tomas P. McFie DC PhD

Tom McFie is the founder of McFie Insurance and co-host of the WealthTalks podcast which helps people keep more of the money they make, so they can have financial peace of mind. He has reviewed 1000s of whole life insurance policies and has practiced the Infinite Banking Concept for nearly 20 years, making him one of the foremost experts on achieving financial peace of mind. His latest book, A Biblical Guide to Personal Finance, can be purchased here.