How to Use an Annuity to Pay for College

by Sean Butner Google

    Insurance companies offer investment contracts, called annuities, that can be settled to provide guaranteed annual payments. The size of the payments depends on how much money is put into the annuity and the terms under which the contract is settled. Typically, annuities are used to guarantee payouts from a retiree’s nest egg. With some creativity, they can be used to fund other ongoing costs as well, such as college.

    The most straightforward way of paying for college with an annuity is to settle an annuity on a limited payout schedule that will make payments that cover tuition. You’ll have to contribute a significant amount to have a sufficient balance to have the payout you’ll need. Consult with the annuity company to find out what the payout per $1,000 in an account is on a limited payout, such as four years. Figure out how much you'll need to invest so that the annuity payouts will cover tuition payments.

    During times where the stock market is performing well, and interest rates are low, you could make better use of your investment by letting it grow and borrowing the money instead. For example, if your annuity is growing at 16 percent per year, and student loan rates are at 3.4 percent per year, by taking money out of the annuity to pre-empt taking out student loans, you’re taking a massive hit in terms of return. Student loans are typically set on a 10-year repayment schedule beginning six months after graduation. Adjusting your annuity to pay out for 10 years and cover your student loan payments allows you to take advantage of the superior returns from the market.

    If you received an annuity as a settlement, you might be able to sell the rights to your payments for a single infusion of money. Some colleges also provide incentives for students to pay upfront, such as allowing them to prepay future tuition at today’s cost, even if tuition later goes up. With the rate at which tuition has increased over the past several years, it’s likely that the savings you’d realize would provide a better return than leaving the money in the annuity.

    For example, say your annuity company tells you they could pay out $300 a year for 4 years for every $1,000 invested in an annuity. You want to cover tuition of $20,000. To settle the contract for annual payments of $20,000, you would need at least $66,667 in the account when you begin payments. Alternatively, you could borrow to cover tuition and use the annuity to cover loan payments. On a principal balance of $80,000, at 6.8 percent interest, monthly payments on the standard schedule are around $920. Assuming the payout falls to $150 a year per $1,000 for a 10-year payment, you would need $73,600 in the annuity by the time repayments begin six months after graduating.

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    About the Author

    Sean Butner has been writing news articles, blog entries and feature pieces since 2005. His articles have appeared on the cover of "The Richland Sandstorm" and "The Palimpsest Files." He is completing graduate coursework in accounting through Texas A&M University-Commerce. He currently advises families on their insurance and financial planning needs.

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