Life Insurance For Kids: Worth The Cost?

Life insurance for children is a complex topic. While it may seem counter-intuitive to purchase life insurance for a child, there are some benefits and drawbacks to consider. The primary purpose of life insurance is to provide financial protection for loved ones in the event of the policyholder's death. As children typically do not have dependents, life insurance is not usually necessary. However, there are exceptions and alternative options to consider.

One key benefit of obtaining children's life insurance is that it can be more affordable and accessible for the child to maintain later in life, especially if they develop medical issues or choose a high-risk career. Whole life insurance policies, which provide lifelong coverage, are commonly purchased for children and can build cash value over time. On the other hand, the likelihood of a child's death is low, and the coverage amounts tend to be low, which may not meet the child's future needs.

Before purchasing life insurance for a child, it is essential to weigh the pros and cons, assess your financial situation, and explore alternative options such as savings plans and investments.

Pros: It can guarantee future insurability, cover funeral costs, and lock in lower rates

Pros of Life Insurance for Children

It can guarantee future insurability

Life insurance for children can guarantee that they will have coverage as adults, even if they develop a medical condition or take up a dangerous hobby or occupation that would otherwise make it difficult or expensive to get insured. This is especially relevant for children who are already at a higher risk of developing health issues due to family medical history.

It can cover funeral costs

Although the chances of a child dying are very low, a life insurance policy can provide funds to cover funeral expenses and allow grieving parents to take time off work without financial worry.

It can lock in lower rates

The younger the child, the lower the premium. Buying life insurance for a child locks in a low rate that they can maintain throughout their lifetime. This can be beneficial if the child develops health issues or takes up a dangerous occupation as an adult, as they are likely to secure more competitive rates as a healthy young adult.

Cons: It's a permanent cost, may be a limited policy, and could be a low rate of return

Permanent Cost

Life insurance for children is a permanent cost that may not be worth it, especially if you already have sufficient coverage for yourself. This is because the primary purpose of life insurance is to provide a financial safety net for loved ones in the event of your death. In most cases, parents do not rely financially on their minor children, so there is no need to buy life insurance for them.

Limited Policy

Children's life insurance policies often offer less than $100,000 in coverage, which may not be enough for your child's needs later in life when they have dependents of their own. The coverage is usually issued at a standard (non-preferred) rate, so it is more expensive than coverage that can be purchased if your child is in good health at age 18.

Low Rate of Return

Whole life insurance policies for children build cash value over time, but they do so at a low rate of return compared to other investment options. It could take a decade or two for the policy to accumulate enough cash value to equal the amount you've paid in premiums. You may be better off investing in a 529 college savings plan or other types of investments that typically have higher interest rates.

Child riders: A cheaper, more flexible, and straightforward alternative to child life insurance

Child riders are an optional add-on to your life insurance policy that provides a small amount of life insurance coverage for your children. They are a cheaper, more flexible, and straightforward alternative to child life insurance. Here are some of the benefits:

Cost-efficiency and affordability

Child riders are a cost-efficient way to insure your children's lives without purchasing a separate life insurance policy. You can add a $10,000 child rider to your term policy for as little as $4.20 per month, whereas a child life insurance policy would cost at least $45 per month or more. This makes child riders a more affordable option for those on a tight budget.

Ease of conversion to permanent policies

Child riders can be easily converted into permanent life insurance policies for your children when the original policy expires. This conversion does not require a medical exam and does not factor in the child's current health condition. On the other hand, purchasing a separate child life insurance policy may require a medical exam and could be more costly.

Coverage for multiple children

A single child rider can typically cover all your children, including future children, at a flat rate. This means you don't have to worry about taking out individual policies for each child, simplifying the insurance process for larger families.

Coverage regardless of health status

Child riders protect your children regardless of their health status, even if they develop a life-threatening health condition later in life. This is especially beneficial if your child has a pre-existing condition, as they may struggle to obtain life insurance as an adult.

Flexibility in coverage duration

Child riders usually cover your children until they reach a certain age, typically between 18 and 25 years old, or until you, the policyholder, reach a specified age, often 65 or 75. This flexibility allows you to choose the duration of coverage that best suits your needs.

No medical exam required for children

When adding a child rider to your policy, your children generally don't need to undergo a medical exam. This saves time and hassle, and there is no risk of your child being denied coverage due to pre-existing health conditions.

Tax-free lump-sum payout

In the unfortunate event of a child's death, the policy's death benefit is paid out as a tax-free lump sum, providing financial support for funeral expenses, hospital bills, and other costs during a difficult time.

Whole life insurance: A permanent life insurance policy that never expires, but it's usually more expensive

Whole life insurance is a type of permanent life insurance that covers the insured person for their entire life. It is more expensive than term life insurance but offers additional benefits.

Whole life insurance policies have fixed, level premiums, meaning the amount you pay each month will remain the same throughout the duration of the policy. These policies also offer a guaranteed death benefit, which is a fixed amount paid to the beneficiary upon the death of the insured. Whole life insurance also includes a savings component, known as the cash value, which accumulates over time and can be withdrawn or borrowed against. Interest on the cash value accrues on a tax-deferred basis, meaning taxes on gains are only paid upon withdrawal. The cash value can be used to pay premiums or supplement retirement income, for example.

Whole life insurance is a good option for those who want lifelong coverage and the ability to build savings over time. It is also useful for those who want to guarantee their future insurability, especially if they are at risk of developing health conditions or taking up dangerous hobbies that could make it difficult to get insured later on.

However, the main drawback of whole life insurance is the cost. Premiums are typically much higher than those for term life insurance, and the cash value may grow at a slower rate compared to other investment options. Additionally, whole life insurance policies offer no flexibility to adjust premiums or the death benefit.

Alternatives: Set up a savings plan, such as a 529 plan, a custodial account, or an IRA

If you're looking to secure your child's financial future, there are several alternatives to life insurance. Here are some savings plans you can consider:

529 Plan

A 529 plan is a tax-advantaged investment account specifically designed to help families save for college and other educational expenses. There are two main types of 529 plans: prepaid tuition plans and education savings plans. With a prepaid tuition plan, you can lock in the current tuition rate and avoid future increases. On the other hand, an education savings plan allows you to invest in mutual funds, exchange-traded funds (ETFs), or target-date funds to grow money for your child's education tax-deferred.

The primary benefit of 529 plans is the tax advantages they offer when used for educational expenses. Investments grow tax-free, and qualified withdrawals are not subject to federal or state income taxes. Additionally, certain states may allow parents to deduct contributions from their taxes. However, it's important to note that using 529 funds for non-educational expenses may result in income taxes and a penalty.

Custodial Account

A custodial account is a taxable investment account opened on behalf of a child. There are two types: Uniform Transfers to Minors Act (UTMA) accounts and Uniform Gift to Minors Act (UGMA) accounts. The main difference between the two is the type of assets that can be used to fund them. UTMA accounts can hold a wider range of assets, including tangible assets like cars, jewelry, and real estate, while UGMA accounts are limited to financial assets such as cash, securities, and annuities.

One advantage of custodial accounts is the flexibility they offer in terms of spending discretion. Unlike 529 plans, there are no penalties if the beneficiary chooses not to use the funds for educational purposes. Additionally, custodial accounts have no contribution limits, allowing you to give as much as you like. However, they offer fewer tax breaks than 529 plans, and gifts made to these accounts are irrevocable.

IRA (Individual Retirement Account)

While IRAs are typically associated with retirement savings, they can also be used as a savings vehicle for children. There are different types of IRAs, including Traditional IRAs and Roth IRAs, each with its own tax advantages and contribution rules.

One benefit of using an IRA for your child's savings is the potential for tax-free growth, similar to a 529 plan. Additionally, IRAs offer a wider range of investment options compared to 529 plans, providing more flexibility in how you build your child's investment portfolio.

However, it's important to consider the impact on financial aid eligibility when using an IRA for your child's savings. Unlike 529 plans, which are considered parental assets, IRAs are typically considered the child's assets, which can negatively affect financial aid calculations.

Frequently asked questions