Life Insurance for Children – Almost Always a Bad Investment

life-insurance-for-children-533x372Over the holidays, many of the movies I enjoyed with my family were laced with commercials suggesting that I should buy life insurance for my children. I can’t think of a WORSE idea to prepare for their future.

Life insurance is a valuable financial planning tool that serves two primary purposes:

1) Providing income for your family. The most important use of life insurance, and what it was actually designed for, is to provide resources when a family breadwinner passes away unexpectedly. This is the main and frankly most important purpose for life insurance.

2) Paying for Estate Taxes. One of the most valuable uses of permanent life insurance is paying for estate taxes at your death. This is frequently used to avoid having to sell large family assets like businesses or real estate. The reality under today’s rules is that only a handful of people will ever pay estate taxes, because the first $10.5 million (for a couple) of most estates is currently exempt from federal estate tax.

Under today’s rules, it’s really hard to justify life insurance for anything other than providing for lost income. Because this limits the number of potential buyers, insurance companies have created some rather interesting ways to use permanent life insurance. They are often sold as long-term savings accounts, and this is typically where the sales pitch comes in for the kids. But for long-term savings there are much better investments that offer significantly lower costs and better appreciation potential.

Buying life insurance for children is almost always a bad investment

Unless your child is a star like Taylor Swift, they probably don’t have an income to replace, so this isn’t normally a consideration. And they likely won’t have a family much before age 20, either. And without income, it’s hard to imagine they’ll be paying estate taxes, either.

So how do insurance agents convince parents to buy life insurance on their children?

Savings. I’ve addressed this already, but if you’re going to save money for your child, you’re generally much better off using mutual funds and investing for long-term growth. Any earnings inside a life insurance policy can only be accessed as taxable income or as a loan, and the administrative costs (and commissions) of insurance take a big bite out of any savings you might have built up. In short, there are much better options, especially for college savings.

Future Insurability. This one is insidious, because it plays at our need for options in the future, and our innate fears about missing out on something. The basic argument is that something might happen to your child that could make him or her uninsurable in the future, so if you buy some insurance now they will always have that available to them. The problem with this argument is that the actual probability that your child will become uninsurable in the future is miniscule. And if you’re worried about a family history of some disease, insurance companies consider your family medical history and the likelihood of future advances anyway when they set the cost of the policy they sell, so if that’s the concern you will still pay a higher cost for the insurance than might be necessary.

Death Benefit. Nothing can be worse for a parent than the early death of a child; the emotional impact of this event is devastating. That said, the financial impact is relatively small (unless your child has significant earnings), so again there isn’t a need for income replacement. Some parents may want to consider a small policy to cover funeral or burial costs, which can run in excess of $10,000 or so, but this is best done with a term life policy should you decide to go this route.

Use Life Insurance Wisely

Life Insurance can be a valuable part of a sound financial plan. But since the costs are substantial and may continue for many years, it’s important to be very selective when choosing whose life to insure. Paying for life insurance on a breadwinner may be a very prudent choice, but paying for life insurance on children’s lives is almost always a waste of money. Contact us to discuss alternatives to buying life insurance for your children and how best to incorporate life insurance in your financial planning.

About Rick Brooks

Rick Brooks, CFA®, CFP® is a partner of Blankinship & Foster LLC and is the firm’s Chief Investment Officer. He is a lead advisor, counseling clients on all aspects of personal financial management. Rick serves on several boards. He is the Chairman of the Board of Girl Scouts San Diego, and also chairs the San Diego Foundation’s Professional Advisor Council. Rick and his family live in Mission Hills. Rick enjoys spending time with his family, theater, cooking, skiing, gaming and reading.

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