“The sooner you save, the faster your money can grow…”
-Forbes.com, “The Five Most Important Money Lessons to Teach Your Kids“
Are you considering buying life insurance for an heir?In last week’s post, “Life Insurance for Children and Grandchildren – The Surprising Benefits,”we revealed why many people decide to get life insurance for children, from newborns to adult children. Among the benefits:
- In a properly constructed policy, the cash value of a policy on a younger insured grows at an attractive rate of return for the policy owner, with no downside risk.
- Life insurance represents unparalleled estate planning benefits, such as the ability to transfer assets to the insured free of income, state, or gift taxes.
- Policy owners appreciate the liquidity and flexibility of the cash value, including the ability to collateralize it or use it themselves, if needed.
- The policies offer protection from financial loss, including the loss of income of a grieving parent.
- Insuring a child guarantees future insurability.
The arguments against insuring children commonly presented in popular financial media are typically either based in ignorance or describing whole life policies that are NOT properly set up or funded with maximum paid-up additions. However, there ARE rules, restrictions, and procedures that you should be aware of if you are considering getting life insurance for a child or grandchild.
Before You Buy Life Insurance for a Child – 5 Things to Know
- Insurance limits. In short, the less you earn or the less your net worth, the less insurance you will qualify for. Since children have little-to-no earning power, their HLV (human life value, an insurance term) is calculated much lower than for their working parents.As a general rule of thumb, a death benefit for an adult will be limited to around 20 times their annual income. Insurance amounts for children are capped at much lower levels – typically about half – than for the child’s parents.There are always exceptions, such as children of parents with a high net worth. In the case of a retiree or someone with significant assets, they will qualify for a death benefit approximately equal to their net worth.
- Low premiums limit cash value.Premiums are also much lower for children than adults because of low mortality rates. The low premiums limit the amount you can save within the policy. As a result, if you’re looking for a way to put LOTS of money into a high cash value insurance policy, you may be disappointed how little you can put into your child or grandchild’s policy.
- Insure yourself first. In general, you can’t get insurance on a child or grandchild whose parents are not adequately insured. We think this is a very good limitation, though in cases where the parents are not insurable for some reason, it can be problematic. However, if one spouse is insured, that can work.And it doesn’t have to be whole life – we often recommend combining whole life unless you have adequate cash flow to insure yourself to your HLV (human life value) with whole life alone.When insuring grandchildren, the same issue arises. In most situations, the parents of the grandchildren will need to have – and will want to have – adequate insurance. We suggest purchasing for oldest generations first, then the next oldest, etc. While any parent can purchase a small whole life policy on a baby, they will be very limited in how much cash they can save in such a policy.
- Permission. The only person you can purchase insurance for without receiving their expressed written consent is your own minor children. This is simply the way that insurance works, for everyone’s benefit.If you wish to insure a grandchild who is a minor, the grandchild’s parents must give written permission for the policy. (If divorced, just the custodial parent’s permission is needed.) Adult children or grandchildren must give their own consent to be insured.
- Insurable interest. If you have no children, you cannot insure a nephew or niece. You may, however, insure a business partner or a spouse. There must be an insurable interest between the policy owner and the insured.
The Process of Getting a Whole Life Insurance Policy for a Child
If you wish to insure adult children or grandchildren, you’ll first need to get everyone “in the same boat.” Adult children may not understand why their parents are getting life insurance, so it is important for you to understand the reasons you are beginning the policies. It can be helpful to share the research you have done, even policy illustrations.
Personally, we like the “Family Bank” metaphor. High cash value insurance policies can be a key way to build a multi-generational “bank” used to pool family resources, provide financing, and maximize savings in a multi-generational legacy. We are developing a short report that will give you more information and suggestions for Starting a Family Bank. We’ll post a comment below when it is available, or feel free to contact us to be sure that you’ll be notified of this resource when it’s available. (April – May 2014.)
Other essential steps to starting a family bank include:
Physical exams and medical history. Children will not get examined at all (depending on the company, up to age 14 or beyond). Insurability is simply determined through medical records. The child’s parents (or the child, if they are over 18) must authorize the insurance company to obtain an “attending physician statement” from their primary doctor.
For some teenagers and all adults, an exam is required. A licensed nurse or paramedical professional will come to your home for your convenience. For younger adults, this will be a very quick a simple exam, involving simple paperwork and a blood and urine sample. Adults may have to go through a more thorough exam. The exam for a teenager or adult involves simple paperwork and a blood and urine sample. This all happens as part of the qualification process, before the policy can be priced or initiated.
Constructing the policy. It is important to remember that there are 3 parties in a Life Insurance contract. The owner, who controls the cash and everything about the life insurance, is the primary role. The insured, who the owner selects, is the person who the death benefit is actually placed upon. And the beneficiary, which can change at any time and is chosen by the owner, is the person who would receive the death benefit.
Typically, 2 people will play these 3 roles. A common arrangement is to have the owner and the insured be the same with someone else as beneficiary. (Dad takes life insurance on himself and MOM IS (NOT A MINOR) the child is the beneficiary.) Another common arrangement is to have the Owner and the Beneficiary be the same. (Dad could own and be the beneficiary of a life insurance policy on a child or grandchild.) In some cases, Dad might insure his grandchild and name the child’s parent (his son or daughter) as the beneficiary.
A trust can also be the beneficiary, which we will discuss further in our Starting
Policy Do’s and Don’ts: If maximizing the growth of cash value is a goal of the policy owner, it is imperative that the policy be set up with the proper Paid-Up Addition riders (PUAs) and that the policy owner understands how their premiums and PUAs are to be paid in order to ensure the optimal rate of return. You’ll also need to follow the insurance company’s instructions to not overfund the policy, which could turn it into a MEC, or modified endowment contract.
We do NOT recommend Universal Life or Indexed Universal Life for children or adults. The only permanent life insurance policy we recommend for children is a whole life policy.
Payments. You will verify with the insurance agent by phone who will be making the payments, but you will also get paperwork in the mail to sign. Premiums can be paid monthly or annually. The policy begins when the first payment is made.
The insurance company will pay for both the exam and the physician’s statement; there is no financial cost, risk or obligation in the process of qualifying for life insurance.
Do you want to buy life insurance for a child or grandchild? Or perhaps you still have questions about the process or whether it’s right for you? Either way, we can help! We even have a P4P team member (Theresa), who specializes in working with our clients in helping clients get whole life policies on their heirs designed for maximum cash value growth and flexibility. Simply fill out our contact form and we will be in touch to set an appointment.
LISTEN: Todd Strobel of Guide to Financial Peace Radio interviews Partners for Prosperity’s Kim Butler about Life Insurance for Children: “How to Buy Life Insurance for a Child.”