Last time I wrote about the best investment a young person can make. Now, let’s talk about the worst.
Maybe it’s just me, but the cable networks I watch have been running a lot of ads for something called the Gerber Life College Plan. Maybe you have seen one? It shows a gathering of nice looking couples with their nice looking toddlers, and the subject of college funding comes up. One couple draws admiration from the others because they have actually started to save for college! Huzzah!
The only problem is that they have elected to save “for college” in the least efficient, most expensive way possible. I put “for college” in quotes because college has precisely nothing to do with the plan beyond a nice marketing angle for Gerber.
If you are a parent saving for college, it may just be the worst investment I have ever seen.
The GLCP is a fancy name for an endowment life insurance policy. It has zero to do with college. Endowment policies are a combination of term life and a savings plan that are designed to meet a target savings amount in a specified amount of time. In the case of a 30 year-old man (the “owner”), he could put away $43.11 per month for 16 years to “endow” a $10,000 policy for when his then two year-old child will turn 18 and presumably need the money for college. In 16 years, the insurance company will hand you a check for $10,000 and they do not care what the money is used for.
Let’s take this apart piece by piece.
The owner receives no tax benefit for making the contribution. College savings plans (“529 Plans”) offer up-front state income tax deductions, up to $2,500 in my home state of Maryland. For example, in Maryland a father could open and plan and a mother could open a plan for their child, each contribute $2,500 per year, and then they take a $5,000 Maryland income tax deduction on their joint state tax return. Of course, every state has their own rules and limits on deductibility but almost all give you at least some benefit.
The owner of the GLCP contract is taxed on its growth each year. The owner of the 529 plan is not taxed on growth ever while the assets are in the plan. Further, provided the proceeds are used for college expenses, the growth on a 529 plan is completely tax-free. This is a staggering tax benefit and one of the few still available to higher income families without regard to their income level. Naturally, the higher your household income at time of withdrawal the greater this benefit becomes.
If you’re handy with a financial calculator, you have already figured out that the rate of return (pre-tax!) on my GLCP is 2.31% per year. One of the biggest benefits they tout of the plan is the lack of risk. Unless you believe in unicorns and the Chicago Cubs you know that without taking any market risk there is no expectation of market returns. Putting your money in the market for a week is risky. Keeping your money out of the market for 16 years is a guaranteed loss.
The one thing that the GLCP does offer that the 529 plan does not is term life insurance. If our owner dies during the term then his beneficiaries get the full endowment as a death benefit, tax-free. So, in addition to the 529 plan go spend a few hundred dollars per year and buy 20 year term life insurance, and that problem is solved.
The bottom line is that I cannot imagine a scenario where someone interested in saving for college is not better served by a state 529 plan. If you need more insurance, buy more insurance.
People (even young, healthy people) need insurance in their lives to cover the real risks they face: premature death, disability, disease and liability. Insurance is a real cost, one that is worth paying because the benefits are absolutely vital when you need them. The moment someone conjures up an insurance plan disguised to cover any other type of need, check your wallet. It is almost exclusively designed to benefit the person selling it at the expense of the one buying it.
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