Though the calculation of an Expected Family Contribution (EFC) is quite formulaic, there are three unique options families can take to reduce their EFC and receive the most assistance. The first option is to use a MEC Whole Life Contract. What we like to call a "bond alternative". In this episode of Money Script Monday, Gabriel presents a sample scenario of a family looking to reduce their EFC by utilizing a MEC Whole Life Contract.
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Welcome back to another episode of "Money Script Monday." My name is Gabriel Lindemann. I'm honored to be your presenter today.
Today, we're going to be talking about college funding and more importantly, when a family needs or wants to use a modified endowment contract (MEC) for college planning and college funding.
So, the big picture is, we have a family. The family has done what they've done best for their kids, they've saved money to go to college. They maybe have $50,000, $100,000.
Whatever the amount is, it's not enough money to get into the school of the child's choice.
And what's really a shame is, even though the parents have done everything correctly, that little bit of money, which would be $50,000 or $100,000 – for most families, that's a lot of money, it'd be a lot of money for me – is keeping them from receiving financial aid. Because when they file their FAFSA, their EFC is too high.
So, the schools are going to say, "Well, you have all this money. We're not going to give you anything." Where the reality is they should be able to get some kind of financial aid, grants, or a scholarship, to pay the difference.
A lot of times, families are disappointed. Now, they saved money for their kid, their kid got accepted at a top-tiered school, a private school, and you have to tell them, "Well, unfortunately, we can't afford it because we saved money for you."
It's a heartbreaking story. I hear it more often than not, but there are solutions.
A common solution we have is, we put money into a modified endowment contract. Now, the reason why we use that product is because of the guarantees.
If we look over here, this sample client, the client has put in $100,000. Because the way we structure it, we're at $99,000 Policy Year 1.
No matter what happens, our cash values are very strong and we design it that way on purpose, so you can have access to your cash value.
By Policy Year 2, you're above the basis. So that $100,000 deposit is above $100,000, and it's pure growth.
Now, what's unique about that, if you were to use any other investment option, that $100,000 would probably be around $60,000 or $70,000, and then build its way up over time. But we design it so that way, we take away all the costs, all the fees, everything. So that way, it's pure growth moving forward.
The drawback is, remember, you do have to pay taxes and penalties, everything above basis.
Short-Term Play for Guaranteed Growth
But for a short-term college solution, it's a good scenario. Because this family now, in Policy Year 1, they're eligible for financial aid and grants and scholarships. And so if they were to receive, let's say, $20,000, $30,000 in aid and let's say the total tuition was $40,000, they would only have to borrow $10,000 out of that policy to pay the difference.
That's a really good scenario.
That's a family that, previously, they were discouraged. Their kid got accepted to a top-tiered school, so they were excited. But then, all instantly, that excitement turns into disappointment because they couldn't afford it. Now, they can.
Again, this is a short-term solution to help that kind of family.
Types of Guarantees
Now, let's talk about the guarantees in a whole life (WL) contract. The reason why you buy a whole life contract, or as I call it, a "bond alternative," is because of the guarantees.
When somebody goes to a bank and purchases a bond, they don't buy it for the long-term growth or the hypotheticals of what they could do. They do it because they know the rates and return are guaranteed, it's for short-term money. But more importantly, they know after a certain time period, that money will be liquid and it's theirs.
Same thing with a whole life contract, we base it based on the guarantees, not the non-guarantees and let's review why.
If we look at the non-guarantees, there are no checks and balances. There is no way to hold the company accountable on what they previously said they were going to do versus what they do.
That's okay. Because if you look over here, the guaranteed growth in the value is so strong in the early years, most companies are going to give you 2% to 3%, to 4% sometimes. And that's all we need because the way we structure the policy to break even so soon. So that's good.
No accountability, we just talked about that. Basically, when you buy a whole life contract and you base it on the non-guarantees, it's just a firm handshake.
You're really hoping that the company comes through on their non-guarantees, which there's no way to tell if they do.
There's no assessment. You can't look to an index like the S&P 500 to get a correlation of what you're going to be assessed in your policy. Nobody knows. It's a firm handshake at best.
But again, it doesn't matter because you have the guaranteed growth. You have guarantees built into the policy for the short term.
Again, very tough in underwriting. Whole life, generally speaking, the way they can give guarantees and the way they give dividends and rates of return are based on mortality costs, mortality credits, and paying out death benefit claims. So they have to be a little bit more conservative.
If you think you have issues, like background issues with your family health-wise, if you're not totally 100% healthy, you're a little overweight, they could rate you and it could cost you more money in the long run because they have to be so tough on that. Because it's short-term money, because they don't tie it to an index, they're tying it to what they pay out, what they earn internally.
So again, they have to be a little bit more conservative.
It's all a tradeoff. It's pros and cons. If you're looking for short-term money for college funding to shelter the money for EFC but, more importantly, to get that money out when you need to pay the difference for college loans and everything, it's a good scenario.
Let's transition over here – accessing your cash.
How often have you wanted to pull money out of your home? What would happen if you had to take $20,000, $30,000 out of your home to pay for school?
Well, it's a drama.
You have to go through refinance, it takes time, you have to have notaries, you have to get approved, new rates of return. You know, what you think should take one week to two weeks is probably going to take anywhere from one month to four months sometimes.
And if you need money right away, forget about it. It's going to take time. So emergencies don't matter in the refinance world.
With a whole life contract, if we design it correctly, that money, we design it to take that money out in the same Policy Year 2. It's built in there.
The liquidity is built in there so that no matter what happens, whether it be for an emergency that something happens with you and your family, or to pay the difference of what you don't get in financial aid to pay for school costs and tuition, it's there.
No loan charges. One of the things that we always recommend, and we advocate, is you always take withdrawals to basis on a MEC policy because everything above is going to be taxable. So you want to take a withdrawal against your policy, so you're not paying any charges or fees and you get your money that much faster.
I reemphasize, you pay taxes above the basis. So as long as you understand that, you're fine.
Tax-Free Death Benefit Protection
Lastly, let's talk about the importance of it. It's a death benefit.
So, what happens if a tragedy happens? Your family is going to be protected that they have that death benefit to pay all of college to make sure their family doesn't have to drop out of school, to accrue more debt.
The money is going to be there tax-free in the form of a death benefit to the family.
When we think about all the options, the number one protection always is the death benefit to the family. Because unfortunately, it's going to happen to us all sooner than later. It's good to know that we can put our families in protection that when tragedy hits, they'll be safe.
MEC Whole Life Contact Recap
Let's review everything today. We talked about a family that was going to go to college. They had some money saved for their son or daughter, but it kind of hurt them because it raised their EFC and now they weren't eligible for financial aid or scholarships.
By putting the money into a MEC policy that removed it from the EFC, they increased their eligibility for financial aid. They received a little financial aid, and the difference that they didn't receive of what the tuition was, they took a withdrawal against the policy to pay it.
Like I said when I started earlier, every family is different. I don't know if this is a good scenario for you and your family or your students.
The whole point of the matter is, you need to work with a certified college planner (CFP) that can review your personal information to determine if this is a good strategy, or possibly another strategy is a better fit for you. Thanks again.