Let’s not beat around the bush. In most cases, purchasing life insurance for your children’s lives wastes money. It’s easy to give in to the emotional appeal that you’re doing the right thing because you want to provide for your kids, but the fact is there are better, cheaper alternatives to help your children instead of buying insurance on their lives.
The primary purpose of life insurance
Life insurance is typically purchased as an income replacement for your untimely demise. It enables your spouse and children to maintain their standard of living, helps with future expenses such as tuition, pays off debt like the mortgage, makes up for lost retirement savings, and pays for funeral expenses.
If your child is the primary breadwinner in the family (i.e. actor, singer, entrepreneur, etc.), then yes, insurance is needed. In most cases, though, children haves no income to replace.
It’s the thought of our worst fears of death or disability that blind us to the unwise financial decision to purchase life insurance for our children.
Funeral expenses often run $10,000+. There may also be counseling and medical bills. While insurance can provide for those events, having an emergency fund would make much more sense. It is available for any crisis, doesn’t cost anything beyond what you need to save, and you can access it anytime without fear of incurring fees.
A life insurance policy will stay in force regardless of changes in your medical condition. Therefore, if your children develop medical problems before they are out on their own, having a policy will allow them to qualify for more life insurance later.
That is a true statement. A child with a medical condition may have difficulty qualifying for insurance later in life. Also, while the guaranteed insurability will allow them to purchase additional insurance later in life, the amount is limited to a multiple of the original policy amount.
That will not be enough to provide adequate coverage, and the cost of the premiums would not be worth the amount of the benefit. Even those with an adverse health history may be able to obtain insurance, mainly through an employer. That would be much more economical.
Another tactic to get you to purchase life insurance is to market it as an investment. That makes me cringe. Promoting life insurance as an investment is just unethical, plain and simple. That goes for anyone, not just children.
If being unethical wasn’t enough, there are additional downsides that outweigh any benefit to using life insurance as an investment.
- High costs: You have to pay for the cost of insurance, various administrative fees, and commissions. Fees within life insurance policies eat away at any return.
- Surrender Fees: Most policies have charges which limit your ability to cash out the policy. That limits your options, especially early in the policy’s life.
There is only one time there is a chance that insurance may come close to being appropriate as a quasi-investment. If you’re a high-net-worth individual and have maxed out or been excluded from contributing to all other qualified retirement accounts. Even then, I’d probably recommend an annuity or a taxable account with tax-free investments before insurance. They are cheaper than insurance.
How many high-net-worth children do you know?
I get another laugh from those who push life insurance to pay for college. If it sounds too good to be true, it probably is, and using insurance for college is.
To begin with, if you withdraw more money than what you paid in premiums, you’ll pay income tax on the difference, income that will go on your FASFA. While FAFSA doesn’t include life insurance as an asset, most private colleges use the CSS PROFILE, which does.
What about a loan from the policy? Sure, but it isn’t free. You have to begin paying it back; of course, there’s interest. The insurance company will love you. High fees are charged for the policy, interest for taking out a loan. Sucker!
No surprise here, but a low-cost 529 plan is the way to go. If you get offered a life insurance policy for your child’s education, run as fast as possible.
Don’t fall into the trap
There are three questions you must ask yourself. The answers will steer you away from purchasing life insurance for your children.
What risks will you be protecting against by buying insurance?
We’ve already reviewed the financial risks, which are not significant enough to warrant the cost.
Who is the beneficiary?
The beneficiary would be you, the parents. If the policy is held long enough, which isn’t likely, it may be your child’s spouse. So, in reality, the policy is not going to help your kids.
What are the alternatives?
Although we’ve mentioned some of them, like an emergency fund and a 529, the best way to help your kids is to ensure you and your spouse have adequate life insurance.
The reality is, if any of our children have an unfortunate disability or medical problem, we as parents will do all that we can. What happens when we’re not around? A life insurance policy with a spouse or child as beneficiary could ensure assistance continues.
The one exception
If it makes you feel better, and you can purchase a term policy through your employer, then go for it. The cost is low for coverage, between $10,000 and $15,000. Do you need it? If you live paycheck to paycheck with no emergency savings, then it’s not a wrong move, and it isn’t going to break the bank. Otherwise, no, it’s not necessary.
What I would not do is get a rider for your children on any policy you have or get them their own policy.
Life insurance for a child is not a good idea unless it can be purchased through an employer’s benefits plan. The primary reason for life insurance is to replace income and cover the significant expenses in the event of an untimely death. The argument for buying life insurance for any other purpose is disingenuous. At a much lower cost, the alternative options available will do more for your children than an insurance policy on their lives.
Do you have any questions or feedback you’d like to share? I’d love to hear your thoughts, so please feel free to leave a comment below.