Six Steps to Financial Freedom, Step Four
I have to confess, I personally did not follow my own advice when it comes to paying for my own education. There are a lot of reasons for that, not the least of which being that when I was young the government programs were different and my parents did not have any extra to set aside anyway. So I did what just about everyone else does, I worked my way through college and got a loan backed by the government that I repaid when I got my first job. Fortunately I went to an inexpensive school and was able to find work right away after graduation so I was able to repay my loan within the first year.
In this day and age there are a number of ways that parents can start saving for their children’s education at an early age and eliminate the need for student loans. The key in all of it is to start early and invest wisely. But I put it down as step four because you should never prioritize children’s education over debt freedom or your own retirement plan. If you can’t afford it you are better off teaching your kids the value of hard work, setting them up to work their way through college or university and yes, in this one circumstance a small student loan is not the end of the world. But I stress small loan. A student loan is not a substitute for work, even if your program is so intense that you can only work in the summer, that’s something at least and it helps set you up for the real world.
So that being said, how do we start saving for our children’s education now?
In Canada there are essentially three vehicles that people can use to save for a child’s education: Registered Education Savings Plans (RESP), Life Insurance and Non-Registered Savings.
The RESP is the most common method and in most cases the best option. People place money into a mutual fund or other type of investment plan tax differed, the government matches your investment with a small grant and when you start school you can withdraw the money at the student’s marginal tax rate, which should be close to zero. If you put the money in a decent growth mutual fund it’s reasonable to expect a return of 8-10%. Add to that the government matching grants and it’s not unreasonable for a well designed RESP to return close to 30% on the money you put in. There isn’t another (legal) investment in the world that gives you that type of return.
Consider this, if you were to start investing $100 per month in an RESP returning 10% with the government grant adding an additional $25 per month to your contribution, the investment will have grown to $70,000 by the time your child is 17. Compare that to a non-registered plan without the government grant you would need to contribute $260 per month, more than 2.5 times a much to amass the same amount of money.
Of course if your child doesn’t go to an accredited school the government takes back their grant money but you would still have the $100 per month that was invested at 10% for 16 years that you could use for anything you chose. That’s still $50,000.
So that’s two ways you can invest for education, RESPs and Non-Registered investments but what about using Life Insurance for education?
Now to be clear, I am not proposing that you purchase Life Insurance as an investment. The purpose of Life Insurance is to cover expenses associated with early death or to replace the income of a wage earner. In the case of a juvenile, if there is a history of illness in the family it’s a good idea to start an insurance program in ensure their life-long insurability before they develop something that would make them difficult to insure in later life, like diabetes or a brain tumor (like happened to my niece at the age of 17). But of none of that happens we can’t ignore the cash value in certain types of life insurance.
Take that same $100 per month. If we were to use it to fund a life insurance policy on a one year old boy we could purchase a Life Insurance policy with a starting death benefit of $110,000. In 17 years that policy would be worth $240,000 with the option to purchase up to another $150,000 of insurance with no medical exam. In terms of funding education, that policy could be used as collateral for a loan at better terms than a traditional student loan or could simply be cashed out for about a third of its official face value. As a pure investment play, Life Insurance is not your best option but if you’ve already maxed out the RESP option and there is any concern about the future insurability of your child you should consider purchasing Life Insurance as a long term strategy.
Life insurance is never any less expensive that it is today. No matter what you do it will always cost your children more to buy insurance for them self than you can purchase it for them today, assuming they are even insurable when the time comes.
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