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Life insurance for children: When it does (& doesn’t) make sense

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Most people understand the need for life insurance coverage for parents to financially protect their children. But what about buying life insurance for your children? Is it necessary?

How much child life insurance makes sense?

Depending on your financial situation, buying a small amount of coverage for children may make sense. It’s not a bad idea to buy a small amount of coverage for your children, perhaps $5,000 to $10,000. If the unthinkable happens and you lose a child at a young age, a small policy can at least cover funeral expenses and other needs. This way, you don’t have to worry about paying for a funeral out of pocket during such a difficult time.

But you typically don’t need a separate policy to provide funeral expense coverage for your children. Many individual term policies for adults have optional child riders that offer coverage for your children. Group life insurance policies also enable you to add dependent children.

A child rider on your term life policy will cover all of the children in your household. Plus, if you decide later on that a child requires their own policy, you can covert the rider into a child life insurance policy.

Life insurance coverage on children typically costs a few dollars a month. That’s because there is little risk of children dying, plus you typically only buy a small amount of coverage on your children.

Child life insurance beyond funeral expenses

Are there situations when your children need more life insurance coverage than final expenses? And do they ever need their own individual policy? For most people, this is rarely necessary.

Remember, the main purpose of life insurance is to replace income that would be lost due to the death of a parent or other financial provider. Children typically don’t earn an income. If they do it’s usually small and not something that’s needed to financially support others. If your child is a singer, actor, or another high-earning performer, a life insurance policy on them may be justified.

A more common scenario in which individual children’s life insurance is potentially needed is if your child has a medical condition that can make it difficult for them to qualify for coverage as an adult. In this situation, you can buy your child a whole life insurance policy, which they can continue owning as an adult. This not only locks in an affordable premium, but also protects your child’s insurability.

Life insurance as an investment

Insurance companies and agents that sell permanent life insurance may present another strategy for child life insurance.

The idea is to buy a child a whole life or universal life insurance policy that builds cash value. The life insurance policy provides permanent life insurance coverage as long as the premiums are paid.

The other part of the strategy is that the cash value earns interest over time and serves as an investment vehicle that the insured child can use for a variety of purposes. The child can access the cash value for college tuition, a downpayment on a first home, or other needs.

Some insurance companies have marketed this strategy to grandparents as a way to gift life insurance to their grandchildren, as grandparents often give financial gifts to their grandchildren. The sales pitch for this strategy emphasizes that the policy accumulates cash value, and does so in a way that it’s not invested in the stock market and therefore can’t lose value.

The grandchild can continue paying premiums to maintain the insurance coverage into adulthood, even for life if they choose. They would never have to worry about having coverage for their own life. Plus, the grandparents can add a Guaranteed Purchase Option (GPO) rider, enable the grandchild to purchase additional coverage at specific later dates without going through the application process.

Why should life insurance not be used as an investment?

Many financial experts argue that using life insurance is the least efficient method of investing.

Many believe even if you invested in a very conservative, low-risk investment you would come out ahead of investing in cash value life insurance.

Cash-value life insurance also has more fees and charges than other types of investments, including sales charges, administrative fees, and the cost of life insurance coverage.

Plus, life insurance doesn’t accumulate as much in the first several years of the policy as a traditional investment potentially would. When you make an initial premium payment of, say, $10,000, you don’t automatically have $10,000 in cash value. That’s because much of the money you contribute early on is used to pay for the cost of life insurance coverage. So while you do have a death benefit at the beginning of your policy, you have very little cash value; in fact, it may even be negative those initial years.

Best ways to save money for children

If saving money is your main goal for buying life insurance for a child, there are a number of better options.

For college saving, a 529 plan is likely a better option. These are special accounts offered and administered by each of the 50 states and the District of Columbia. A 529 plan is a tax-advantaged savings plan designed to help pay for education, including college, private K-12 school and apprenticeship programs.

The two major types of 529 plans are savings plans and prepaid tuition plans. Savings plans grow tax-deferred, and withdrawals are tax-free if they're used for qualified education expenses. Prepaid tuition plans allow the account owner to pay in advance for tuition at designated colleges and universities, locking in the cost at today's rates.

If you want to help your child or grandchild save for other purposes, you can help them invest in a mutual fund or a custodial account that you hand off to them when they turn 18 or 21.

Jack Wolstenholm is the head of content at Breeze.

The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.

— Published February 17, 2021
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