Look to stock funds to save for college


October 18, 1992|By JANE BRYANT QUINN | JANE BRYANT QUINN,Washington Post Writers Group

New York -- A question from reader Stacy Mills of Griffith, Ind. addresses a choice that tens of thousands of parents are struggling with today: What's a good way of saving money to pay for a college education?

When Stacy, then 28, and her husband, Jonathon, 27, confronted the problem, they were grappling with another personal finance issue -- they needed more life insurance. So they figured they'd solve both problems at once, by buying whole-life insurance coverage. Over time, whole-life policies build up cash. You can borrow that cash when it's time for your children to go to school.

The Millses bought two $100,000 policies -- one for each of them. But Stacy soon started having doubts. "We're putting $150 a month into this plan," she writes. "Is that smart?"

I put her question to New York City insurance consultant Glenn Daily, who analyzed the return the Millses might get on their life insurance accumulations.

His answer: No way, for this couple and everybody like them. You'd do better by buying cheap term insurance and investing the rest in stock-owning mutual funds.

There's a case to be made for saving for college in the type of policy known as "universal life," Daily says. But only if you own the policy already and are an extremely conservative saver. Daily wouldn't buy such a policy specifically for the purpose of saving for college, long term.

Here's why life insurance won't do the job that college savers are hoping for:

* The return on investment is lower than you think. Take the Millses' policies, which come from Northwestern Mutual Life Insurance Company (NML), based in Milwaukee. Right now NML pays a sky-high dividend interest rate of 9.25 percent on cash values, tax deferred. But after expenses, the rate is much less.

Most cash-value policies actually lose money in the first five years. For Jonathon Mills, the compound annual loss could come to around 8 percent, Daily found. That's chiefly due to the cost of the upfront sales commission. Over time, the yield improves. By the 15th year, on this analysis, it's up to 6.2 percent. But that's a lot less than the 10 percent Mills should get from a good stock-owning mutual fund, held for 15 years. (Projected yields on insurance policies depend on the assumptions made; so the figures are ballpark, but the conclusions, sound.)

Furthermore, it's highly unlikely that NML will continue to pay that high dividend rate. So the Millses will probably earn even less.

* Even if that high rate never drops, this amount of life insurance won't build enough cash. After 15 years, the Millses would have roughly $42,000 to borrow against. If NML's dividend rate dropped to 7.25 percent, they'd have $33,000. By contrast, the price of four years at a state college will have exceeded $100,000 by the time today's toddlers are ready for school.

* When college time comes, you won't want to borrow against your whole-life insurance anyway. NML currently charges 8 percent on policy loans. It also lowers the dividend paid on the money that you borrow against, by nearly 2 percentage points. That's a total effective borrowing rate of 10 percent. You'd do better by taking a student loan or a loan against your home equity.

Loans against your insurance policy have some other ill effects. They reduce the cash proceeds your family gets if you die. If you own the type of policy known as universal life, you can add extra cash to it. That cash earns the current rate of interest, tax-deferred. If you withdraw that money -- say, to pay for college -- you pay no loan interest, although you may pay a surrender charge.

Income taxes may or may not be due, depending on circumstances.

Still, the return even on superior universal-life policies isn't great for college savers, Daily says. So for young parents, the advice remains: Buy term insurance and stock-owning mutual funds.

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