Funding an Expensive Goal with a High-Cost Product is a Bad Idea

Annuity salespeople are being threatened by the new regulations on retirement accounts; this is forcing them to expand their hunting grounds to prey on parents trying to fund college costs.   Unfortunately, college savings accounts are not covered by the new rules.

According to Troy Onink, many parents are being instructed by unscrupulous salespeople to cash out of their children’s existing college saving accounts. They are then “advised” to place these funds inside an annuity or permanent life insurance contract order to supposedly shield these accounts from FAFSA. (This is the form that is prepared, annually, by college students to determine their eligibility for financial aid.)

These salespeople contend that this maneuver will increase the child’s chances of getting financial aid, since annuity/insurance contracts are not considered to be assets that are figured in federal financial aid calculations.

Not surprising, this ‘too good to be true’ yarn, spun by conflicted salespeople, is just that!

There are so many holes in their flawed argument that one could drive a bus filled with hundreds of S.E.C. regulators through it!

There are numerous reasons why this is not a smart strategy; first one being: Not all colleges use the FAFSA form to determine financial aid.

According to Onink, “Non-qualified annuities are counted as assets on the CSS Profile, another aid form used by about 300 colleges, in addition to the FAFSA.”

The bottom line is this “strategy” is useless for most high-priced private institutions that many parents are targeting for their children’s education.

Second, this strategy can lead to a high tax bill, often negating the positive effect it may have on the financial aid part of the equation.  Parents may need to sell assets that have substantial capital gains embedded in them in order to purchase one of these insurance contracts. These rates can be as high as 23.5% at the federal level, with an additional state levy.

In addition, if an annuity is used for college funding purposes, “…You would typically borrow money from the policy if you wanted to pay for college; that amount is owed with interest and must be repaid,” according to James Canup.

It gets worse if you decide to take a distribution, instead of a loan, from the policy.  You would have to pay taxes on any amount you received that was above the total premiums you paid into the policy.

Finally, if you are below age 59 ½, an additional 10% penalty would be due on these distributions.  Additionally, a surrender charge could also be imposed (depending on how long you owned the annuity) making this proposition one of very dubious value.

Third, parents with high asset levels tend to have income levels that would preclude them from receiving needs-based financial aid, thereby defeating the whole purpose of the strategy. The only thing most high-income parents will show for implementing this high-cost gimmick is an even bigger tax bill from Uncle Sam.

Finally, the huge commissions associated with these types of products are an insurmountable drag on investment returns.

According to Scott Simmonds, “Commissions can eat up 50% to 120% of policyholder’s premiums.” He states, “That is partly why it takes most policies at least 8 to 10 years to accumulate enough cash to pay for college.”

This fact negates the argument of selling assets to stash them into annuities a few years before classes begin. Using this strategy will finance a college education. The problem is the children of the salesperson who sold you this lie will be the ones who will benefit from it!  Those commission dollars should take care of a nice high-rise dorm for his kids, while your own children will be left out in the cold.

While low-cost annuities can have a place in a holistic, goals-based plan, they don’t belong in the college funding sleeve.

Noted college planning expert, Mark Kantrowitz , says it best:  “Speak with a fee-only investment advisor (who doesn’t sell annuities or life insurance) about the pros and cons of such an investment before you buy it. An annuity salesman doesn’t have a fiduciary responsibility to you.”

Funding a high-cost goal with a high-cost product is a very bad idea. Usually, if something sounds too good to be true, it often is.

Annuity costs can turn a four-year college dream into a multi-year, costly nightmare.