Nobody likes to contemplate the death of a child. We’d all like to assume that our children will outlive us. Nevertheless, it does happen, from time to time.
Over the years, I’ve found that some families are more open to considering life insurance on a child than others. The reasons are usually cultural or emotional, and sometimes parents will respond very negatively to even bringing the subject up. And you have to respect that. So much of financial planning involves dealing with emotionally touchy subjects as it is –and one’s money should be a servant of one’s own ideals.
That said, I am a believer in parents holding a very small life insurance policy on a child – for a number of economic and financial reasons. Let’s take, as I’m fond of saying, a closer look.
Death Benefit. First and foremost, the dominant reason to purchase any life insurance policy is always for the death benefit. True, unless your little one is a child actor or model, chances are she isn’t going to be much of a breadwinner. Indeed, they tend to be bread eaters, rather than breadwinners, for an inconveniently long period of time.
But that doesn’t mean the family doesn’t have real, material financial damages when the unthinkable occurs, and a child dies. In the real world, the financial burdens are heavy – especially since they primarily affect young families just starting out. Few parents of very young children can withstand the sudden and simultaneous effect of the following routine expenses:
Final medical expenses. Insurance doesn’t cover everything – especially if you’re on an 80-20 plan or one with a high deductible. Further, doctors are usually willing to undertake aggressive and expensive medical treatments and surgeries to potentially save a child’s life. The parent is responsible for anything the insurance plan doesn’t cover – and these costs can be very significant, even with insurance.
Funeral expenses. These can be very pricy, as well, and can rise into the tens of thousands of dollars. Older folks tend to “pre-pay” funeral expenses in exchange for a discount on funeral and memorial services, markers, etc. This pretty much never happens with children. Parents pay full price. (If you are active in a church or synagogue, they will typically help you, though, if they have any kind of a budget – just as you would help others in your congregation in a similar situation.)
Time off work. This is a frequently overlooked expense. But one or both parents will likely want to take some time off work after losing a child – especially if there are other young children in the home who will need a little TLC for a while. A month off work for two parents can easily mean $6,000-$10,000 of money you don’t earn – on top of everything else.
Any time survivors would experience a significant and severe financial hardship from the unexpected death of another, I think life insurance is worth a look. And children are no exception. Parents who choose not to own a policy, or who avoid the question altogether, are simply taking on the risk themselves, rather than offloading it to the insurance company.
Here’s something you won’t learn from very many people in the consumer financial media: If you do it right, life insurance on a child works out to be free.
Why? Because if you take out a very modest permanent insurance policy (not term), and you fund it adequately, you will be able to take more in cash out of it than you ever put in it. You won’t profit right away… life insurance is a “front-end loaded” product. That’s how the agent gets compensated. But after a number of years, depending on how well you fund the policy, you should be easily in the black. Keep up the funding with whatever you can afford, and you should have a tidy sum available for college expenses, a wedding present, a down payment on your baby’s first home, a cash graduation gift – or heck, keep it yourself!
I think life insurance is one of the better college funding vehicles out there, for one simple reason: Life insurance is the only savings mechanism that will self-complete, if you become disabled. That is right – if you purchase something called a “waiver of premium” rider on a life insurance policy, and you become disabled and unable to work, the insurance company will take over whatever you had committed to funding.
For example: If you have a newborn baby, and you want to put $100 per month away in a college fund, you can buy a policy on your baby. The cost of life insurance is very low on young children. Just overfund your policy over and above the minimum by $100 per month.
If you write one check, and you get disabled in a wreck the next day, the insurance company will take it over for you, and pay that money for the next 18 years on your behalf. It self-completes in the event the policy payor becomes disabled.
No mutual fund will do that. No Section 529 plan will do that. No bank will do that. Your accountant or stockbroker won’t do that. Only the life insurance industry will do that.
Financial Aid Considerations
If you are concerned about college costs, and qualifying for financial aid, consider this: Cash value in life insurance policies is not held against either you or the student for the purposes of calculating your expected family contribution under the federal financial aid system.
For middle class families who are too well off to get a need-based ‘full-ride,’ but not wealthy enough to pay full price, this can be a critical consideration. Assets in a parent-owned 529 plan count against you and your family when they calculate financial aid eligibility. So does money in private savings (though there are ways to mitigate this by having other family members own some of these accounts, you also have the risk that the family member will use the funds for their own purposes, rather than for college savings).
This money is also available, penalty free, if your child does not go to college, or receives a full scholarship (there are some tax consequences for surrendering a policy outright, however).
If your child ever wants to have a family of her own, she will need life insurance of her own, as well. But there are a lot of things that can happen in adolescence or young adulthood that could make it difficult or impossible for your child to buy life insurance then. For example, a medical condition like multiple sclerosis, depression, alcoholism, drug addiction, cervical cancer, and early onset diabetes will make getting coverage very expensive. A felony conviction as a 19 year-old can blow out a young person’s insurability for years, and possibly permanently.
If you buy a policy on a young child, the insurance company cannot revoke the policy for any of the above reasons. Your child will still retain the right to keep the insurance in force at preferred rates.
Furthermore, many policies will guarantee the right to buy up to 5 times the face amount of the original policy when the child turns 18, 21, or some other age specified in the contract. So you can convert that $50,000 policy on your child to a $250,000 policy when she is ready to take on a family of her own. There are ways to magnify the effect even more than that, using term riders on your baby’s policy. Your agent can show you how that works, and every company works it a little differently.
Where Life Insurance is NOT Indicated
All these are terrific things. But life insurance is occasionally oversold, as well. After all, agents are trying to make a buck, too. They don’t get paid on policies they don’t sell. I’d be careful about buying life insurance for a child under the following circumstances:
- You cannot afford sufficient life insurance coverage for yourself and your spouse.
- You cannot cover all children equally.
- You cannot afford to “overfund” your life insurance policy with extra cash every year. (I would estimate that it generally requires a premium contribution of $3,000 to $6,000 per year or more to really make the strategy work.)
- You are skimping on your own retirement contributions and other critical insurance coverages.
- You don’t need or want the death benefit.
- Your income is not reliable and you cannot commit to funding the policy for more than a couple of years.
- Your life insurance agent is pushing this policy without having done a thorough fact-finder on you and your situation.
- You have medical conditions which disqualify you for the waiver of premium rider (though the policy could still make sense for other reasons).
Life insurance planning is highly fact-dependent. There is no one cookie-cutter answer. If you want an independent look at the question of life insurance for your children, or you simply want to go over your family’s general life insurance plan, college funding plan, or both, call us today and make an appointment!