Should your clients buy life insurance for their kids? It may sound like a crazy question, but it’s not. Due to a child’s long life expectancy, the premiums are cheap. Underwriting is simplified and expedited. There is always a chance that junior could become uninsurable as an adult. Meanwhile, life insurance is one way safety-minded investors can save for their children.
Parents can buy term or permanent life insurance for their children or attach a family rider to their own life insurance policy to cover the kids. Life insurance policy sales for kids under 18 make up about 20 to 25 percent of all insurance sales, according to LIMRA. Those sales, according to LIMRA spokesperson Catherine Theroux, have been steady over the last decade. She does not expect sales of life insurance to children to rise.
Most of the policies sold to children are so-called “small face amount” whole life policies, which have a small death benefit of between $25,000 and $30,000. Twenty-five percent of children in the United States have individual life insurance coverage and 26 percent, she says, are covered under group policies. The average coverage for children with individual policies is $23,600; for children with group policies it’s $20,700.
Insurance experts say that financial advisors should help clients carefully consider the merits of buying coverage for their kids. Insurance is generally designed to provide income to a family when the breadwinner dies.
“In general you insure a risk,” says Anthony Domino, Jr., a New York-based financial planner and past president of the Society of Financial Services Professionals. “There is no economic benefit to the children. Insurance is for a financial loss to the breadwinner. ”
Parents, he adds, may be paying life insurance premiums for an event that has low odds of paying off. There are some cases in which buying a policy on a child’s life might make sense.
“The most common reason for purchasing life insurance on the lives of children and grandchildren is to lock in their insurability for the future,” says Steve Hamilton, senior consultant with Nationwide Financial Services, in Columbus, Ohio. “Since no one can guarantee a person's future health or insurability, the time to get life insurance is when the person is healthy.”
Another reason, Hamilton suggests, is to cover the costs associated with a child's final illness and death. Plus the death benefit may replace some of the parents’ lost income during the child’s illness.
Some parents buy life insurance on a child’s life to provide financial stability for the day when a child marries and wants to raise a family. The parents may purchase a whole life insurance policy that is paid up when the child reaches adulthood. The benefits include locking up low premiums for life, a guarantee that the child will be insured in the future, and cash value build up. With a guaranteed purchase option, an adult child can raise his or her insurance coverage without producing evidence of insurability, which involves taking a medical exam.
“Another reason people buy life insurance on children, especially whole life, is the savings aspect,” Hamilton says. “The policy death benefit is there for burial expenses, or to cover future un-insurability, but if all goes as planned, cash values can supplement other goals, such as education or a down payment on a house as the child grows up.”
Hamilton says parents or grandparents often buy universal life insurance. The policy can be designed to have a limited premium payment period, or have the premiums paid for the life of the policy. If the goal is to develop cash value, more premiums can be put into the policy versus paying just enough premiums to keep the policy in force. A $100,000 universal life policy that is designed to pay premiums for life and to provide coverage to age 100 under current assumptions may cost $4.80 per $1,000 of coverage annually for a one-year-old male and $4.68 per $1,000 of coverage annually for a one-year-old female.
With whole life policies, the premium is usually fixed. A $100,000 death benefit “20 pay whole life policy,” which is paid up in 20 years, may cost $6.93 per $1,000 of coverage annually for a one-year-old female and $7.75 per $1,000 of coverage annually for one-year-old male.
Typically, the insurance products purchased for children are designed to last a lifetime and not just for a specific term. Most term life insurance products cannot be purchased prior to age 18. But Hamilton adds that there are some specially designed juvenile products that start as term policies, but automatically convert to higher face amount whole life policies at a specified age, usually 21 or 25. These often are referred to as "jumping juvenile" policies since they are initially purchased at low face amounts, $25,000 or less, and "jump" to a face amount that may be five times the original face amount.
Insurance companies offer many different choices for coverage. For example, parents could get a $30,000 whole life insurance policy on the one-year-old boy from Mutual of Omaha for just $198 annually.
Other insurers, like the Savings Bank Life Insurance Company of Massachusetts and Thrivent Financial will write $100,000 policies on children. With Thrivent’s policy, the insured could pick up an additional $60,000 of coverage on each birthday, from age 16 through 43, for potential additional coverage of $540,000.
Family insurance plans are another option. A married couple with children could purchase family protection at a low cost. For example, New York Life’s plan for a family of four can cost just $458 per year, assuming the father is 35 years old, the mother is 32 years old and the kids are five years old and two years old. The parents each would get $250,000 of coverage. Each child and any additional children would get $10,000 in coverage apiece.
Despite solid reasons for buying life insurance for children, financial planners often advise against it. Jonathan Pond, a Boston-based financial planner, says parents may be spending money for insurance that may never be used.
He dislikes the idea of parents buying life insurance as an investment to fund part of a child’s higher education. Life insurance is very costly. Commissions can be more than 50 percent of the first year’s premiums. There also are insurance charges, state premium taxes and surrender charges, which can run more than 200 basis points annually.
Parents are better off investing in mutual funds in a tax-deferred 529 plan, Pond says. These plans allow contributions to grow tax deferred and distributions may be used tax-free to pay qualified higher education expenses. Many states also offer taxpayer deductions of as much as $5,000 annually for contributions into their 529 plan accounts.
Minors can’t own insurance. The parent owns the policy. But when ownership reverts to the adult child, Pond says, policies often lapse.
“You might have to buy a ton of insurance and you don’t know if the insured will hold onto the policy,” he says. “If a policy has cash value, they might spend the money for unintended reasons.”