With tuition skyrocketing, parents of college-bound kids face a wrenching financial decision: drain their savings into college tuition or burden their children with student loans. The good news is that there are ways to pay for college while protecting your savings all at the same time. And one of the most effective ways is to lower your expected family contribution (EFC) score when applying for financial aid. In this episode of Money Script Monday, Gabriel shows you the three options you can employ to lower your EFC score and maximize your child's eligibility for grants and scholarships.
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Hello. Welcome back to another episode of "Money Script Monday". My name is Gabriel Lindemann, and I'm honored today to present the three expected family contribution (EFC) options for college funding.
I know what you're thinking. You're thinking, "Gabe, there's probably hundreds of ways to pay for school." And there is. But when all is said and done, there's only three options that can effectively lower a family's EFC.
And that's the name of the game. It doesn't matter if you're a family of 4 that makes $100,000, $200,000, or $500,000. You want to have the lowest EFC possible so that way you're going to be eligible for the most amount of grants and scholarships.
So we'll just talk about the three options, and there's only three options out there, that can effectively lower a family's EFC.
#1: Bond Alternative (MEC Whole Life)
The first option is the bond alternative, better known as the modified endowment contract (MEC) whole life.
Pros of MEC Whole Life
The reason why people would pick that option is because of guaranteed rates of return.
In the whole life contract, they're going to guarantee you anywhere, based on the company, 2% to 3% guaranteed rates of return.
The death benefit, if a tragedy does happen, you want to have the safety and security to know that your family will be taken care of. Or more importantly, those student loans will be covered as well. So death benefit is very important.
And liquidity features. What happens in policies in year three or four? A tragedy happens, your son or daughter needs to drop out of school, or God forbid, your health comes to concern and you need money for medical expenses, this policy and this option has liquidity features where you can get almost 90%, or many times, 99% of the funds out of the policy to pay for such tragedies. Now, obviously, those funds are gone and they're not going to be used for college, but it still has liquidity features out there to protect you in your time of need.
Cons of MEC Whole Life
Now, everything that's good has something bad. There's pros and cons in everything in the world.
It does have lower rates of return. When we're talking about 2% to 3%, that's best case scenario. So, if you're looking to get rich on this, this is not designed for that at all.
It's not a long-term solution. This is typically for a solution under 10 years. Families fund it as a lump sum contribution, and they're expected to pull out money either next year or in policy year three or four, and pull it out for about four to five years. After 10 years, it's not long-term because the rates of return aren't there.
And furthermore, because you've pulled money out of the policy to help pay for college loans, extra family costs, the policy might not last that long either.
Lastly, this is purely and only an EFC option. This isn't financial planning. This is purely just to lower EFC, have the money there in a safe policy that's going to give you guaranteed rates of return. But by no means is this something that you can use for long-term family protection.
#2: CD Alternative (Stacking MYGA)
Let's transition over to the second option, which is very popular. It's a CD alternative, which is a stacking multi-year guaranteed annuity options.
Pros of Stacking MYGA
Now, why would somebody want this over the MEC option? Well, because it has, again, guaranteed rates of return. But those rates of return are typically going to be higher. We're looking at 3% to 5% in a MYGA option. Versus the MEC option, you might only get 1% to 3%.
Time is of the essence. On these options, you have to wait at least two to three years before you take out income. Whereas the MEC option, you can take out income next year.
So, if you have time, it's going to be better.
And like I said before, it's higher rates in returns than the MEC option. So if a family has $100,000 but effectively they might need $125,000 or $130,000 over a 5 to 6-year period, you can get that based on the guarantees in the CD alternative option. Whereas the MEC option, there is not enough time, not enough rates of return to get that needed extra income for college expenses.
Liquidity features. Again, those you can pull out an additional 10% every year, some of them have death benefit options, if you get sick, to pull out.
You'll have to contact your financial advisor and you can find out all the liquidity features on every single type of MYGA option out there.
Cons of Stacking MYGA
Now, like I said, there's pros and cons. The rates of return are relatively low. In this economy, we're seeing most of our portfolios are getting 9%, 12%, 15%.
So, telling the client they're only going to get 3% to 5% might not be so appealing when you're looking into the equities market. But again you're moving this portfolio because of an EFC move. So 3% to 5% is still pretty good.
And if you were to go to a bank, what would they be giving on a five-year CD? Maybe 1, maybe 50 basis points. It's not going to be 3% to 5%.
So, if they compare it apples to apples, you're still ahead over everything.
Not a long-term solution, this is designed to be short-term. So again, you're pulling out money, you're stacking them. So you might use a three, four, five, or six-year option to pull out money in three, four, five, and six.
By the end of the surrender period, the money is pulled out and you're paying those college loans. Or if you receive enough financial aid, you just put it back in your bank account. It's only an EFC play.
Again, this is not a long-term solution, this is not long-term financial planning because the rates of return aren't high enough. And frankly, they're only using it for short-term solution to short-term problems.
Something to keep in mind, some profile schools, which is considered the top private schools in the country, they will count this.
Work with your financial planner, work with your certified college planner to find out if the school that you might be attending, if this could hurt you. If it does, then you don't want to use it. You're better off using the MEC option instead. But if it doesn't and you need better rates of return, the MYGA option is the suitable option and, you know, it's used all the time.
#3: Roth Alternative/7702 (Indexed Universal Life)
Now let's transition to my favorite option, the Roth alternative/7702, which is an indexed universal life (IUL) contract.
The reason why I like this so much is because this is true financial planning. This is actually when you buy this policy, you're doing it for college planning to lower the EFC. But most importantly, you're also using it to get a rate of return for your retirement.
And know, like I said before, the other two policies, they will also lower the EFC but they're not effective as a retirement vehicle.
Pros of Indexed Universal Life (IUL)
An IUL policy grows tax-free and also have the ability to take distributions all tax-free.
It is long-term planning. So when you buy this, we're looking to take out income four to five years to pay for college loans, then we're going to let it grow tax-free, and you're going to borrow at retirement age, again, tax-free.
This is the only vehicle out there in the college planning world that you can pull money out to pay for college while lowering the EFC…
… but more importantly, the money will be there for retirement purposes.
There are liquidity features as all IULs have. So, in the event that you get sick and you need access to your funds, they do have provisions built in there that you can get your funds out earlier than expected.
Talk to your financial planner or your college planning specialist to go over that.
Death benefit. Again, what happens if tragedy happens and the parents passed away in policy year two or three? You know the money will be there to pay off the student loans and help the family get back on track.
Cons of Indexed Universal Life (IUL)
Now, what are the cons? It does need time to grow. This isn't something you can pull out money next year, or in two years, or three or four. You pretty much need to let it cook for at least five years. So this has a little bit more of moving parts to it.
Again, work with your financial planner or your college planning specialist. They know how to go over that. But typically, you need to wait at least five years to let it grow, to grow and to get the accumulation value so that we can borrow against it.
This is also one of the most expensive ones up front because it has front-loaded expenses.
Over a 10-year period, it may seem expensive because it's very similar to a mortgage payment. Whereas in the first 10, 15 years when you pay a mortgage payment, most of your mortgage payment goes to paying taxes and paying everything that's not fun.
After about 10 to 15 years, it gets more cost-effective and lower.
This is the best option, cost-effective option over a 20 or a 30-year period.
When you compare it to other financial vehicles out there, it is half the cost, if not a third the cost of everything else combined out there.
For a long-term product and for college planning, it is the most cost-effective over a 20-year or 30-year period. For short term, it may not be your ideal option.
If you want to get rid of it in 5, 8, and 10 years, you may be better off using option 1 or option 2, just because of the up-front expenses.
But if you understand rates of return, arbitrage, and an IUL, and you want something that's going to lower your EFC, the index universal life is the best option out there for long-term growth and cost-effectiveness over a 20 or 30-year period.
Now, you might be saying, "Gabe, which option is best for me?" The answer is I don't know. Every family is different. There's so many variables and moving parts.
My recommendation is to work with a certified college planning specialist, so they could determine which option is best for you.
And it might be a combination of options. You might have two to three kids, you might have to do stacking MYGAs, or an IUL option, or you might only have an option of a bond alternative.
We won’t know until you work with your financial professional to figure out what the best option is for you. My name is Gabriel Lindemann. Thanks again for attending today's "Money Script Monday" episode.