Alternative Ways to Provide for Children: Life Insurance and Educational Insurance Plans

For parents who may not have many assets to leave to their children, particularly young parents, life insurance and educational insurance plans may be good options for providing for their children’s future.

Life Insurance

Life insurance can be a major financial resource for children in the event that one or both parents die while the children are minors. An insurance company cannot legally pay out the policy to a minor so an adult must be named as the manager of those funds until the child is of age. If no manager has been named, a court will appoint a property guardian to manage the distribution of the funds.

To avoid having a court appointed guardian, parents should either provide for a manager through the UTMA or in a child’s trust (see previous posts for more information on UTMA and trusts for minors). Using a will to leave insurance proceeds for a child is a little trickier since many insurance companies are concerned that the policy beneficiary is not technically in existence when first named. To avoid this bureaucratic confusion, it is advisable to simply use a living trust.

Educational Insurance Plans

There are two main ways the federal government allows for tax-free educational plans. Each type has its advantages and disadvantages depending on each family’s financial situation and educational needs.

529 Plans

Many people have heard of 529 Savings Plans but few realize there are also 529 Prepaid Plans offered in certain states. 529 Savings Plans essentially function as an IRA or 401(k) account. Each parent may contribute up to $14,000 a year to the plan and the contribution will be free of gift tax. Also any increase of worth in the plan assets as well as any distribution of plan funds is tax-free.

529 Prepaid Plans are not as popular as the Savings Plans and they are only offered in a few states (although many states offer similar plans under a different name). These plans allow you to pay for all or part of a child’s college tuition now at the current cost, in order to avoid having to pay the inflated price of the education in the future. These plans are essentially “futures contracts” in which you lock-in the current price of the tuition. There are several types of prepaid plans (some allow for a per unit payment, some are for vouchers and discounts off the price of tuition) and speaking to a financial adviser can help parents determine which one is right for them.

Coverdell Education Savings Account (ESA)

The Coverdell ESA has long been known as the Education IRA. Recently in 2002, the Coverdell ESA underwent some modifications that make it a more attractive option for education savings. Similar to 529 saving plans, any increase in the value of the account is tax-free and no income tax is imposed on withdrawals made for qualifying reasons. However, unlike a 529 plan, the annual contribution is capped at $2000 per beneficiary. Another main difference is that parents may use the Coverdell ESA for any type of education (k-12 as well as college). Because of the low annual contribution amount, Coverdell ESAs are especially attractive to grandparents or other relatives who want to help parents pay for their child’s future education.