The Costs & Rewards of a College Education

Part 5 - College Funding Options: IRAs, Insurance, and Rebate Programs

There are other, less recommended, alternatives in funding a child’s education.  Examples include taking distributions from your IRA accounts, variable life insurance policies, and using reward/rebating programs.

IRA Distributions

Generally, if you take a distribution from your IRA before you reach age 59½, you must pay a 10% additional tax on the early distribution. This applies to any IRA you own, whether it is a traditional IRA (including a SEP-IRA), a Roth IRA, or a SIMPLE IRA. The additional tax on an early distribution from a SIMPLE IRA may be as high as 25%.  However, you can take distributions from your IRAs for qualified higher education expenses without having to pay the 10% additional tax. You may owe income tax on at least part of the amount distributed, but you may not have to pay the 10% additional tax. The part not subject to the additional tax is generally the amount of the distribution that is not more than the adjusted qualified education expenses for the year.

For purposes of the 10% additional tax, these expenses are tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance.  In addition, if the student is at least a half-time student, room and board are qualified education expenses.


Variable Life Insurance Policies

Variable Life combines life insurance with a tax-deferred investment account, and provides tax-free access to the cash value of the policy. Some insurance companies promote variable life insurance policies as a college savings vehicle because the value of the policy is sheltered from financial aid need analysis formulas.

The advantages of a variable life policy are as follows:

§    The money is sheltered from the financial aid need analysis process and has no impact on financial aid.
§    Very high limits on the amounts you can invest.
§    The parent retains control over the money.
§    One can withdraw or borrow contributions tax-free without penalty.

The disadvantages to such policies are as follows:

§    Variable life insurance products tend to be expensive, with high commissions and expenses. The total return after subtracting costs often makes such policies less attractive when compared with other college saving options.
§    The premiums on a variable life insurance policy will eat into the gains you could make from the money you are paying.
§    Premiums are not tax deductible.
§    Withdrawals from a variable life policy will reduce the death benefit.
§    If you withdraw more money than the premiums you paid into the policy, you will pay income taxes on the difference.
§    Withdrawals from a variable life policy cause the insurer to move a portion of the remaining balance into a fixed-return account to minimize the company's risk.

Loyalty Reward / Rebating Programs

Loyalty programs, also known as affinity programs, provide a rebate to the consumer in exchange for shopping at particular retailers or purchasing particular products or services.

Typically, such programs do not require you to show a membership card to get the rebates. Instead, you register your credit cards with them and they track the purchases you make at participating merchants using the cards. You can also earn rebates by shopping online through the company web sites. This makes the programs a painless way to earn a little extra money for college.

Affinity programs with a college savings emphasis include:

BabyCenter:  (http://www.babycenter.com/index.htm)
BabyMint (https://www.babymint.com/)
FutureTrust:  (http://www.futuretrust.com/)
LittleGrad:  (http://www.littlegrad.com/)
SAGE Tuition Rewards Program:  (http://www.tuitionrewards.com/)
Upromise:  (http://www.upromise.com/)

Of these, Upromise has the largest retailer network, followed by BabyMint. LittleGrad has the largest online retailer network, and all programs listed are completely free to the user.

A key benefit of all of these programs is that you do not need to change your purchasing habits to earn rebates for college savings. The retailer networks associated with these programs are large enough that most families will earn some rebates without altering their spending patterns. Of course, by carefully targeting your purchases, you can maximize your rebates.

Some of the loyalty programs allow one to redeem the rebates as cash instead of investing them in a section 529 college savings plan. Some also allow one to transfer the rebates to repay student loans.

The rebates received from a loyalty program are not subject to income tax or sales tax. (Many states charge sales taxes on all gross receipts from sales, including rebates for which the retailer is reimbursed. However, the consumer already paid sales tax on the amount of the rebate when they purchased the product or service that generated the loyalty program rebate, so no additional sales tax is due when the rebate is received.)

We do not recommend spending more money just to earn a rebate. If two products provide equivalent value, but the more expensive item offers a rebate, sometimes it is better to buy the less expensive item. Compare net prices after subtracting the amount of the rebate. The average rebate is between 4% and 5%.

Over the next few weeks I will begin discussing the various income tax incentives for college savings and expenses.  More specifically, I will be outlining how the Hope Tax Credit and the Lifetime Learning Credit can be utilized to give you a more advantageous tax liability each year.