Buying whole life insurance for your children seems like a good idea. It acts like a savings account you set up for them that one day they can use and take advantage of the cash value in the policy. But there are several logistical hurdles to juvenile life insurance that you need to understand before you jump into a new whole life policy on your children.
Do you Need Life Insurance on your Kids?
I want to take a moment to address a consideration about buying life insurance on your children that has nothing to do with the cash value accumulation of a juvenile policy. Some people appropriately ask, do you really need life insurance on your kids? After all, they normally don't provide income for the family. So what purpose does having life insurance on them serve?
This is a reasonable question and one you should certainly have in mind if pursuing a life insurance policy on your children. It's an important aspect of one of the major hurdles I'll get into when it comes to buying life insurance on children when cash value accumulation is the goal. But for now, let's simply discuss the appropriateness of any death benefit at all on a child.
For the most part, no, you do not need life insurance on a child insofar as you won't lose family income per se if they die. But, losing a child is a mighty challenging moment in one's life. It's an event generally followed by a greaving process that can stretch for an incredibly long time and even permanently alter your outlook on life. Life insurance on a child has nothing to do with recouping income lost from the child (unless you happen to be the parent of a wildly successful child actor). It does, however, provide the needed funds to process immense pain should such an unthinkable event take place. Simply, if your child dies, you're going to need some time away from work to handle the emotional toll, and a small life insurance policy can certainly buy you this time.
Thinking about slightly less dark scenarios, juvenile life insurance policies also ensure at least some degree of life insurance should your child develop some sort of health issue that makes applying for life insurance difficult later in life (more on this later as well when we get into the impediments I mentioned above about cash-focused life insurance purchases).
The Problem with Buying Cash Value Life Insurance on your Children
There are a few different reasons people seek out a cash value life insurance policy on their child(ren). In my experience, they boil down to the following:
- They understand that younger people pay lower insurance rates, so they assume children must get the best deal.
- They want to save money for their child's behalf and figured life insurance was a great option given its safety of principal.
- They want to save for college and figured this was the way people do it with life insurance.
- They fell in love with something like Infinite Banking® and want to ensure their child learns it as well, so buying a policy on him/her is the way they figured was best to teach them.
While I've categorized primary motivations, there is often overlap among the categories.
While these motivations are certainly noble and well-intended, many of them have subtle–but extremely important–hurdles that can often derail the intended strategy.
Children Do Not Get Lower Insurance Rates
Most of us come to understand that insurance costs are correlated with age. This is mostly–but not completely–true. The correlation is actually with the empirically observed probability of death, which generally increases with age. Fun fact, males have a higher probability of death through their 20's than in most of their 30's. Life insurers, however, do not charge 20 something males more for life insurance than 30 somethings. Instead, they use various curve smoothing adjustments to costs that ultimately result in most males in their 20's paying more per unity of life insurance relative to age than males who buy in their 30's–this doesn't mean necessarily that they pay more absolutely than 30-year-old men.
While children generally have a lower probability of death than someone in their 70's, issuing a whole life or universal life insurance policy on them is somewhat risky business for a life insurer. There is a lot about the child's health that is completely unknown. The life insurer needs to price life insurance appropriately to handle the possibility that the child could develop some disease that shortens life expectancy in his/her teens, 20's, etc. Life insurers do use expensing methods to account for this and this practice can absolutely weigh on how well the policy accumulates cash value.
Take the following example, let's say a 35-year-old father wants to buy a whole life policy with $10,000 per year in premium using a design that maximizes cash value. If the father is the insured, here's a ledger of projected values for his policy:
Now here is the ledger if his newborn son is instead the insured:
Notice that the cash values at inception are nearly identical, but the death benefits of each policy are vastly different. This is due to the minimum required death benefit required to avoid Modified Endowment Contract violation.
Now look at the cash values at year 20. The policy where the father (who is 35 years older) has more cash value than the policy where the son is the insured. And again, there is a vast difference in death benefit because of the MEC requirements.
Practically speaking, I should also mention that the feasibility of getting the juvenile policy through underwriting is close to non-existent. Justifying a $1.2 million death benefit at inception will take an incredibly unique set of circumstances that likely don't exist.
College Planning Should Insure the Adult not the Child
Life insurance as a tool to save for college has high strategic value largely due to its ability to help the parent accumulate more wealth versus more traditional methods (if you are interested in a detailed discussion on this, we discuss it in Predictable Profits).
But a lot of people incorrectly look to insure the child for whom they plan to save money. I understand the association problem people make here, but let me give you my thoughts on why this leaves you very strategically vulnerable.
When the child is the insured, and the parent pays the premium, there is a serious risk of failure in the plan should the parent die. Death of the parent leaves someone needing to continue the premium payments, and that may be impossible at that time.
When the parent is the insured, death of the parent means the death benefit automatically creates the funds to afford college with no future premiums requirements. If you're interested in more details on how life insurance works as a college planning tool, here's a video we created on the subject:
Whole life insurance is an okay way to save money on your child's behalf, but it's limited in terms of the true capabilities it has when the adult is the insured. As long as you are okay with those limitations, you can certainly use it for a juvenile insured.
But small life insurance policies on children do a lot more to provide grief capital should a child die unfortunately young and that's a far better way to deploy precious resources.
Juvenile policies are limited in terms of allowable premium and incur additional expenses adult policies can generally avoid, this drags down the rate of return on juvenile policies. So if you are looking to optimize return on premiums, it's best to insure your own life instead of your child's in a whole life policy.