Should I buy life insurance for my child?
Q: My wife and I have been married for two years and we just had our first child. A friend of mine sells life insurance and says I should buy a life insurance policy on my daughter. He says it would be very cheap and would be a good way to save for her future. I’m not sure I like the idea, but what do you think?
A: As they say: to a hammer, everything looks like a nail. I see it all the time in my financial planning practice. Real estate people buy real estate. Stockbrokers only want stock. And sometimes, insurance people think the answer to every financial question is life insurance. While real estate and stocks and life insurance play important roles in almost every financial plan, you will get a better result if you use the tool that is right for the job at hand. Life insurance is not the best way to save for a child’s future.
I have heard three sales pitches for buying life insurance for children and none of them hold a lot of water for me.
Pitch #1: Buying life insurance now will protect the insurability of your child. No matter what health problems she may face, your child will always be able to buy life insurance in the future.
While this could theoretically benefit a child who develops a major illness, most policies for children are far too small to make much of a difference in the life of an adult. Most adults—especially those with dependent children—need somewhere between $500,000 and $2 million in life insurance. In contrast, the Gerber “Grow-Up Plan” life insurance policy (one of the most popular children’s policies) can be written for coverage between $5,000 and $50,000. This is clearly not going to make much of a difference in the life of a grown up.
At the same time, most 20- and 30-year-olds have no trouble qualifying for life insurance and their life insurance rates are cheap. Buying a life insurance policy on your child and paying those premiums for all those years, seems like a lot of effort and expense to protect against an unlikely risk.
Pitch #2: Buying life insurance can help your child save for future expenses like college.
Most childhood policies build up cash value over time. You can think of the cash value in a whole life policy like a savings account. A little bit out of every premium payment gets put into cash value where it grows tax-free over time. When you cash out the policy’s cash value, you will pay tax on any growth in the policy.
What you need to understand is that the rate of return you will earn on a whole life policy is tiny. In fact, if you want to use life insurance solely as savings vehicle, your money will have a negative return until your child reaches middle age. Why? Because only a small portion of what you put into the policy actually gets invested. Most of the premium pays for the policy’s death benefit.
If you want to save for your daughter, a much better idea would be to contribute a little each month to a 529 plan. While it’s in the 529 plan, the money will grow tax-free. And if she uses it for college, she can withdraw it tax-free, also.
Pitch #3: A life insurance policy on your child could help pay for funeral expenses in the event of her untimely death.
Personally, this is the pitch I dislike the most. Statistically, the odds of a child dying in the United States are very slim. If the unthinkable were to happen, you would adjust a few things and have the resources to deal with her final expenses. Instead of worrying about something like that, wouldn’t it be better to take a more positive approach and invest in her future?
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to: firstname.lastname@example.org