“If you want to start an argument, ask a group of financial advisers what they think about buying life insurance for children.”
Should you get life insurance for a child? Don’t people only “need” life insurance if they have a family to support? Why do people insure their children and grandchildren, and does it make sense to insure an heir?
We believe that life insurance is a WANT, not an absolute need, and there are several reasons why a lot of people – who have done their due diligence – WANT to get life insurance for their children.
As a matter of fact, at Partners for Prosperity, we’ve received more and more requests recently from people who want to set up life insurance policies on their children! Why? There are many reasons – we give you five below – and often, the biggest reason is the first:
1. People desire to maximize the growth of their savings (cash value) in tax-advantaged whole life policies. The younger the insured is, the lower the cost of insurance is within the policy, which means that cash value grows more quickly and at a faster rate. The internal rate of return on a whole life policy on a younger person engineered for maximum cash value (maximizing paid-up additions) is currently around 5%. That’s about 500 – 5,000% better than most bank CD rates.
This ability to store cash safely at a respectable rate of return is especially attractive for people over 60 who want to save (or perhaps store cash removed from a 401k) without the risks of the stock market. It also helps them to avoid an annual tax bill on the growth of their savings. Best of all, the money can be collateralized with tax-free loans, which means that it can keep growing even while being leveraged for an emergency, opportunity or major purchase using an “infinite banking” strategy.
Life insurance is often thought of as “insurance against death,” but whole life insurance is structured to provide benefits during the whole life of the policyholder. Many of the strategies used to benefit from whole life during your life are described in the powerful little book, Live Your Life Insurance.
2. The estate planning benefits are virtually unparalleled. This is a major motivation for many people who would like to transfer assets to heirs. If your intention is to transfer some or all of your wealth to your children or grandchildren, life insurance is one of the best ways – bar none – to do it. You can pass unlimited amounts of cash to the next generation via a “transfer of the policy to the insured” income-and-estate-tax-and-gift tax FREE… with no need for probate, a trust, or even a will (though trusts can be useful, and we always recommend having a will.)
I can’t tell you how many times I’ve had to repeat that last sentence to stunned clients hearing this revelation for the first time. “Wait a minute… estate and income and gift tax free?” Yes, you heard correctly. There are no taxes when giving a life insurance policy, no matter how much cash value it holds, back to the insured. You simply declare them as your beneficiary and your cash value and death benefit will becomes theirs; no muss, no fuss, no interference from the IRS or the state. You can even give them cash value while you are living just as easily and tax-free.
3. The flexibility and liquidity of the savings is compelling. Cash value can be used in endless ways for the benefit of the policy owner and the insured child or grandchild. As discussed in “Financial Flexibility: Saving too Much in All the Wrong Places?“we are often advised to save in ways that divide our wealth up into accounts which we don’t control or can’t easily access. Too often, “our” money doesn’t feel much like ours as it becomes subject to the rules of our employer, the government, or some other entity. But in a whole life policy, the policyholder retains the ability to withdraw or collateralize the cash value - even when the insured is a child or grandchild.
Let’s look at an example of a policy taken by a parent or grandparent on a child.
What if your intention is to save for future college tuition for the insured child? Investors are typically advised to save money in the ubiquitous 529 savings plan. There are up front tax savings which might be attractive, though if college plans change, this will backfire. When saving in a whole life policy, the policyholder is not subjected to the restrictions of a 529 plan. Cash value can be used or borrowed against by the policy owner should they need it for retirement or non-education expenses. It can be withdrawn or leveraged to help the child purchase a car, a home, or start a business.
If the child goes to college as planned, the money saved in a whole life policy won’t have to be declared and counted against them when it’s time to qualify for financial aid. And if the child chooses not to take the traditional university route, cash value can be used to fund a business, volunteer work, a self-designed internship, or other alternative life-education experiences.
4. Insurance covers expenses in the rare case of such a devastating loss. While a commonly understood benefit, this is the one that nobody wants to talk about. Insurance for children is inexpensive, but funerals, memorial services, and other final expenses are not. Nobody deserves to be burdened with sizable expenses or debt in a time of grief. But final expenses aren’t the only financial concern that motivates some parents to get life insurance for their children.
While life insurance traditionally insures the “human life value,” or lifetime earning value of the insured, the parent taking out the policy also receives the benefit of insuring their own income, which they know would be affected in the event of such a loss. As one mother put it when a financial advisor asserted online that you should “never” purchase insurance for children,
I am a mother of two, and the primary breadwinner for the family. And I can tell you right now, though the chances are slim, if something were to happen to either of my children, I’m not sure when I’d be able to return to work. I can’t even make a guess. So for me, having a financial cushion to make it possible for me to grieve without the worry of when and if I can return to work is a priceless safety net.
Additionally, some parents have been able to use life insurance benefits to fund charitable works done in the child’s name. They find that the ability to leave such a legacy gives some meaning in the midst of loss.
5. Future insurability. According to the Juvenile Life Insurance Foundation, many policies even offer an option to purchase additional insurance in the future (up to $2 million), regardless of future insurability. While insurability is only rarely an issue for a minor, how often do young adults in their 20′s and 30′s “intend” to get life insurance, but never get around to it? Guaranteeing insurability is a life-long benefit for the insured, whether they are one year old or twenty-one.
Are there downsides to getting life insurance for children? Yes, the insurance industry has some rules and restrictions and you’ll want to be aware of the limitations. For instance, you’re somewhat limited in how much insurance you can purchase, which limits the amount of cash value you can build. Starting a family bank (as high cash value policies are often referred to) also requires a lot of communication and cooperation.
Stay tuned for more details about insuring children and grandchildren. Next week we’ll give more nitty-gritty details about insuring children and grandchildren, and some tips and instructions for starting a family bank!
Tune in to Guide to Financial Peace Radio to hear No BS Money Guy Todd Strobel interview Kim Butler about “Life Insurance for Your Child or Grandchild”.