In the world of “financial advice” there is certainly no shortage of bad ideas. Today's podcast focuses in on one particular concept that we think is particularly dumb.
There are some savvy marketers out there that would suggest if you are not able to obtain life insurance coverage for yourself (for one reason or another) you can still benefit from all of the awesomeness that is cash value life insurance.
Yes, all you need to do is to use your child as the insured and then you can dump all the premium you would have paid to your policy into the policy for your kid.
Seems like a great idea…in theory.
In fact, we have had the idea pitched to us by so many people in the industry over the years that we now use at as a barometer of sorts to indicate a lack of experience from the person doing the pitching. Why will it…not work?
Why is buying life insurance on your kid, a bad idea?
We're not saying it's a bad idea to buy life insurance for your children. In fact, it's a great idea to protect them from the risk of having some adverse health event while growing up that may prevent them from securing coverage as an adult.
Additionally many life insurance companies offer some form of an additional purchase rider that allows your child to purchase more insurance without underwriting at prescribed ages in the future. Also, a great idea.
So what am I referring to when I suggest that buying life insurance on your kid is a bad idea?
I'm specifically referring to an instance where you were planning to heavily overfund your life insurance policy (either whole life or universal life) with the intention of boosting your internal rate of return on cash value but you can't do it because you're not insurable.
In those cases, our typical client is putting 20-30k per year into a policy. That would mean that by purchasing a policy on your child, you'd be paying $20,000 per year in premiums into a policy on a 10 year old (as an example).
It doesn't work.
The death benefit (a secondary concern for us in this scenario) is not a secondary concern for the life insurance company. And as you can imagine, a $20,000 premium purchases an incredibly large death benefit on a 10 year old…think something north of $5 million.
Turns out, insurance companies don't think you have any justification to have a $5 million policy on your 10 year old. There's the rub.
Sounds like a good idea but it doesn't work as some would suggest.