Life Insurance for Your Child?

The idea of buying life insurance for your child may seem a bit out there. Most people think of life insurance as a means for income replacement for a parent if he or she were to suddenly pass away – you certainly don’t rely on the income of your child to keep your family financially stable. Getting your own policy is an important first step to consider since a life is dependent on you.

If you earn $75,000 per year, for example, and suddenly pass away, a term or whole life insurance policy would ideally cover your death expenses, debt, and a portion of your income for a predetermined amount of time so that your family would be able to maintain its financial stability. If you’re a single parent, then you have more of an obligation to ensure your child is financially protected.

Of course, the thought of your child passing away is not something a parent wants to consider. However, life insurance for children offers more than just a death benefit, and can serve as an excellent tool for parents who want to secure their child’s financial future.

Protecting Your Child’s Financial Future

A recent survey conducted by T. Rowe Price found that parents are insecure about their own financial future and their children’s financial future. Just 50% of parents “are regularly setting aside money to save or invest and only 43% have set a savings goal.” Forty-three percent say they regret not saving enough, 32% say they regret spending too much and falling into debt, and 29% regret that they started saving too late. Thirty-nine percent of parents say their own parents did a poor job of teaching them how to be financially responsible.

Most parents are aware that their own behavior will have a lasting impact on their child’s behavior, most notably when it comes to money. The survey indicates they know it from personal experience. A life insurance policy for your child can get them off on the right foot financially, also ensuring you remain financially disciplined.

  • Secure a low premium long-term: A child in good health is able to secure a policy with a low premium, which can be renewed as they age, including when they reach adulthood. Parents are pleased to discover they can get a policy without submitting to a medical exam. If health issues arise while the policy is in place, you – or your child if they’re an adult – won’t have to deal with the difficulty and expense of securing a new policy. Having a low premium later on will allow your child to easily insure their own kids if and when they choose to have them.

  • Maintain cash value: If you choose to get a whole life policy for your child, then it will have cash value, the amount the policy is worth if it’s canceled. When you make payments on a permanent policy, a portion of the money is funneled into a tax-free account that grows over time. This will enable your child, when they become of age, to borrow against the policy, which is always better than borrowing money from you or asking you to cosign a loan. Few young people are fortunate enough to have such a valuable asset as they embark on financial independence.

  • Save for college: The primary benefit of cash value is that it can be used by parents to save for college. All of the above benefits apply – it’s tax-free, grows over time with interest, and holds the overall value of the policy. What’s more, it isn’t factored into federal financial aid calculations, so parents who earn too much to qualify but need the aid may receive assistance down the road. It should be noted that many financial experts endorse more efficient ways to save for college. Ultimately, it’s your call, and if you decide you would prefer to use another means to save for college, then the cash value will remain and can serve another purpose.

Before purchasing a policy, consider the differences between whole and term life insurance. Whole life policies, as mentioned above, include an investment component and remain in effect for the insured’s whole life. As a result, it’s typically more expensive than the alternative term life policy, which contains only the death benefit and is in effect only for a period of time to which you and the insurance company agree. Those who merely want a death benefit, have tight budgets, or prefer to invest their money other ways are often advised to choose term life policies.

Parents should secure a policy, whole or term, that would cover the financial burden that follows the death of a child. Funeral expenses can surpass $10,000, and many parents choose to enroll in bereavement counseling and take time off of work, both of which can cost a significant amount of money. Taking everything into account, it’s typically safe to get a $50,000 or $100,000 death benefit.

Other Options for Parents

It may not be in your best interest to purchase an entire life insurance policy for your child. Some financial advisers dislike life insurance for children because they feel such policies cover risks that are not very likely to occur and thus are a waste of money – very rarely do children develop major health problems. Some feel there are a variety of more efficient ways to save for college. Here are some alternate routes:

  • Add a rider to your existing life insurance policy: Many life insurance companies allow policyholders to add a rider to their policy covering the death of their child. Riders are lower maintenance and typically less expensive ways to expand a policy. You may find that you can add a rider covering your child for a mere $5 as opposed to the $10 cost you encountered when researching a separate policy for your child.With many companies you can choose the amount of coverage you need in units with a minimal cost per month added to your premium. Some health information from your child may be required by your life insurance company so they can properly underwrite the policy. The rider lasts until your child reaches adulthood, at which point it’s usually converted into additional coverage as part of your policy. That way, you have something to show for the years of money you invested in the rider.

  • Investigate other ways to save for college: A more popular alternative to saving for college would be to invest in a 529 plan. These are sponsored by states, state agencies, or educational institutions and offer federal and, in some cases, state tax benefits. You can opt for either a pre-paid tuition plan, which allows you to pay for tuition long before your kids enroll in college, or a college savings plan, an investment account consisting of your choice of stock mutual funds, bond mutual funds, money market funds, and age-based portfolios.Mutual funds are not federally insured or guaranteed by state governments, so there is inherent risk. With a life insurance policy, you’re sure to get at least a modest return. And, unlike a life insurance policy, the presence of a 529 plan affects the amount of financial aid you’re awarded.A Coverdell Education Savings Account is another tax-free college savings method endorsed by many financial advisers. An ESA is like the 529 plan in that it’s built through investments and money can be withdrawn tax-free. The main difference between the two is flexibility, as the ESA allows you to fund elementary or high school tuition, or non-tuition items such as textbooks, a computer and other supplies, tutoring, and transportation. However, the maximum you can contribute to an ESA is $2,000 per child per year, whereas with a 529 plan, you can add anywhere between $100,000 and $350,000 depending on the state.