529 Plans vs. Indexed Universal Life (IUL) Insurance

College and other educational expenses can be a significant financial challenge for many families. Two options often considered to manage these expenses are 529 plans and indexed universal life (IUL) insurance. A 529 plan is a tax-advantaged savings vehicle specifically designed to cover future education costs, offering tax-free growth and tax-free withdrawals when used for qualified educational expenses. Meanwhile, IUL insurance is a type of permanent life insurance that provides both a death benefit and cash value component. While the cash value from an IUL policy can be used to help fund education costs, that’s not its primary purpose.

If you are looking for ways to fund education, a financial advisor can help you compare different options.

What Is a 529 Plan?

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education expenses. Named after Section 529 of the Internal Revenue Code, these plans offer significant tax benefits, including tax-free growth and tax-free withdrawals when funds are used for qualified education expenses. This covers a broad range of educational costs, including tuition, fees, books, supplies, and even room and board at eligible institutions.

There are two main types of 529 plans: prepaid tuition plans and education savings plans:

Prepaid tuition plans allow you to purchase credits at today’s rates. These credits can be used for future tuition and fees at participating colleges or universities.
Education savings plans, on the other hand, function more like investment accounts. You can invest your contributions in a variety of options such as mutual funds or ETFs. The account’s value fluctuates based on the performance of these investments.

Advantages of 529 Plans

When it comes to saving money for education-related expenses, 529 plans have several major advantages, such as:

Flexibility: Account holders can change the beneficiary to another eligible family member if the original beneficiary decides not to attend college or receives a scholarship. Plus, the money in these accounts can be used for more than just college tuition. Supplies, room and board, and the cost of trade school are just a few of the many qualifying expenses.
No income limits and generous contribution limits: There are no income limits for contributors. Contribution limits are also quite high, approaching or exceeding half a million dollars in many states.
State tax deductions and credits: Many states offer state tax deductions or credits for contributions to their own 529 plans.

What Is IUL Insurance?

IUL insurance is a type of permanent life insurance that combines a death benefit with a cash value component linked to a stock market index. Unlike traditional whole life insurance, which offers fixed interest rates, IUL policies could offer higher returns based on the performance of the chosen index.

To clarify, returns are not directly tied to stock market investments. Instead, the interest credited to the policy’s cash value is determined by the performance of the chosen index, with caps and floors typically set by the insurance company.

As a result, policyholders can benefit from market upswings while being protected from market downturns because of the established floor. This helps keep the cash value from dipping below a certain level.

An IUL policy offers flexible premium payments and adjustable death benefits, allowing policyholders to tailor the plan to their changing financial needs and goals. The cash value component of the policy also grows tax-deferred, meaning you don’t pay taxes on the gains as long as they remain within the policy.

You can access your accumulated cash value through loans or withdrawals to fund education expenses, retirement income, your emergency fund and more.

However, it’s important to note that IUL policies can be complex. They may also involve higher fees and risk compared to other types of life insurance. A financial advisor can help you determine if an IUL policy aligns with you long-term financial objectives and risk tolerance.

Advantages of IUL Insurance

IUL insurance serves a different purpose than 529 plans, and has its own unique advantages to offer, such as the following:

Versatility: IUL insurance not only provides a death benefit to beneficiaries, but also serves as a financial tool for wealth accumulation and estate planning. You can also adjust your premiums and death benefit amount to better suit your current financial situation, if needed.
High return potential: Policyholders can choose how their cash value is allocated among different index accounts, giving them control over their investment strategy. Compared to other insurance types that grow at a fixed rate, UIL insurance provides a higher potential for growth. Plus, floor rates prevent your cash value from dropping when the market takes a hit.
Tax benefits: The cash value of your IUL insurance grows tax-deferred, allowing it to accumulate more efficiently. Plus, beneficiaries don’t have to pay taxes on the death benefit.

529 Plan vs. IUL: What to Consider

A parent researching the differences between 529 plans vs. IULs.

When planning for future financial needs, take the time to understand the key differences between a 529 plan vs. IUL insurance. Both are valuable tools, but they serve different purposes and offer unique benefits. Consider the following:

Primary Purpose

529 Plan: Designed exclusively for saving for education expenses.
IUL: Provides life insurance coverage with a cash value component you can use for various financial needs.

Tax Benefits

529 Plan: Contributions grow tax-free, and withdrawals are tax-free when used for qualified education expenses.
IUL: Cash value grows tax-deferred, and loans or withdrawals from the cash value can be tax-free under certain conditions. The death benefit is also tax-free.

Investment Options

529 Plan: Offers a range of investment options, typically including mutual funds and age-based portfolios.
IUL: Cash value is linked to the performance of a stock market index, but funds aren’t directly invested..

Flexibility

529 Plan: Can only be used for education expenses; changing the beneficiary is allowed within certain limits.
IUL: Provides flexible premium payments, adjustable death benefits, and you can use the cash value for various financial needs.

Risk and Guarantees

529 Plan: Investment performance can fluctuate based on market conditions, with no guarantees on returns.
IUL: Includes a floor that protects against market downturns, but may involve higher fees and complexities.

When to Use Each Account

Choosing between a 529 plan and an IUL insurance policy ultimately comes down to your financial goals and priorities. While both options offer advantages, they also come with potential drawbacks.

A 529 plan is best suited for individuals or families who are primarily focused on saving for future education expenses, especially when they have a longer time horizon. These plans provide strong tax benefits, including tax-free growth and tax-free withdrawals for qualified education costs. If you’re confident the funds will be used for education, a 529 plan offers a simple and effective solution.

On the other hand, an IUL policy may appeal to those looking for a more flexible financial tool that can adapt to evolving needs. In addition to providing life insurance coverage, an IUL allows the policyholder to build cash value tied to the performance of a stock market index. This cash value can be accessed for a variety of purposes, such as supplementing retirement income, starting a business or covering education expenses. For individuals seeking both protection and growth potential, an IUL can be a valuable option.

However, it’s important to note that IUL policies are generally more complex and expensive than 529 plans. While they offer unique advantages that 529s cannot, they may not be the best fit for every family’s financial situation.

Bottom Line

A parent opening a 529 plan for his son.

Both a 529 plan and IUL can help you save for future educational expenses. But it’s important to understand the differences between a 529 plan vs. IUL before making a decision. A 529 plan is a straightforward, tax-advantaged way to save for education, making it a good choice for families focusing on funding future schooling costs. On the other hand, an IUL policy provides both life insurance protection and the potential for cash value growth, offering the versatility to fund financial needs beyond education.

Financial Planning Tips

A financial advisor can help you create a personalized financial plan for your educational needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area. You can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Use SmartAsset’s quick and easy savings calculator to project how your nest egg will grow over time.