Unless your child is the family breadwinner, buying a policy for him is a waste of money. Or is it?
When I was very young, my parents bought a $10,000 life insurance policy from a friend who was an insurance agent. The policy was on my life -- a 5-year-old. Why would they do that?
The practice of selling life insurance for kids is very widespread. But why should we buy a policy for our kids, when they're supposed to outlive us by decades? Life insurance is supposed to help replace income if a breadwinner passes away, but few kids contribute financially to a family. Unless your child is a successful actor -- though his loss would be emotionally devastating -- it wouldn't shake a family's budget.
Salespeople say the policies will help pay for a child's funeral, for example, in case anything should ever happen. Others say the policies can be used as a forced savings plan for college tuition payments. I vehemently disagree. Here's why:
The tragic loss of a child can have a financial cost as well as the obvious emotional cost. Funeral expenses can range from $5,000 to $15,000 or more, depending on where you live and how extensive the funeral arrangements are. True, most of us don't have that much cash lying around. But there are other ways to pay for final expenses.
Often, when young children die unexpectedly or after an illness, people offer money to help the family. Many people start charity bank accounts earmarked for helping the family get through their time of loss. Relatives donate funds, too. Funeral homes are also sympathetic, and realistic about money. If you did ever have to use your local funeral home, it's likely that you could create a payment plan that your budget could handle.
Another option is dipping into your emergency fund. Financial planners agree you should try to save an amount equal to three to six months' worth of expenses, which can step in when you need it.
Some insurance salespeople say you can use a child's life insurance policy as a forced savings plan for college. Sure, you can, but I don't think it's financially wise. Insurance policies are generally laden with high commissions. Yes, most cash-value policies let you take out what you've paid in premiums with no taxes owed, and you can often borrow against the policy. But the returns earned by most life insurance policies pale in comparison to mutual funds held outside of a life insurance policy.
Instead of putting college savings into an insurance policy, you could just invest what you would be paying for premiums in a separate account, perhaps in a no-load growth mutual fund. All of your money would be working towards the college goal, instead of a percentage going into a salesperson's pocket.
I've said it before -- if you need insurance, buy insurance. If you need to invest for college, retirement or another goal, then invest for that goal without paying additional fees and commissions.
While I'm generally not thrilled with life insurance for kids, there can be good reasons to consider buying a policy for your child.
For example, if there's a history of an illness in your family, such as a genetic disease, for example, you might want to buy a policy for your child. When your child grows to be an adult, if she comes down with the disease, buying insurance can be very costly. Even if your child becomes "uninsurable," if she already has a policy, she'll be able to increase coverage through that policy. And having the policy before a disease develops means the premiums will be much, much cheaper.
Most policies do allow the policyholder to increase coverage. So if your child grows to have a family and needs $500,000 of coverage, she may be able to upgrade the $10,000 policy you bought for her as a child -- and the premiums will likely be less than what the child would find with a new policy.
But fortunately, most children won't develop diseases that will make them uninsurable, or even put them in a higher-risk pool. And life insurance rates are generally very low for healthy adults, so your child should easily find a policy when he reaches adulthood. So unless there's a family history of disease, life insurance may not be the best option for your kids.
My parents bought my policy all those years ago from a friend's son who was just getting started in the life insurance business. It was more of a favor to get him started than anything else. But it's a good thing they did.
When I was pregnant with my daughter, I developed gestational diabetes. The disease stuck around after I gave birth, and it makes new life insurance policies much more expensive for me than before I was diagnosed with the disease. Instead of getting a new life insurance policy, I'm planning to increase the death benefit of the policy my parents bought for me. The premiums will be much cheaper than the high-risk premiums I'd have to pay on a new policy.
Thanks, Mom and Dad.
Karin Price Mueller is the author of Online Money Management (Microsoft Press, 2001).