By: Randall A. Denha, J.D., LL.M.
Even though I’m a trusts and estates lawyer and not a commissioned insurance salesperson, I’m an advocate of purchasing life insurance on your children or grandchildren. I have it on my own children from the time of birth. Also, if you’re in a good place financially and being on track for your retirement, it makes sense to at least consider using a policy as an accumulation vehicle.
In case you’re wondering, yes, I carry life insurance on my children that is very similar to what I recommend here. Think of all the special events in the lives of your children or grandchildren: Birthdays, holidays, graduations, weddings,—even celebrating the birth of a new little one. And if you’re like some of us, you spend hours trying to think of the perfect gift for the occasion—something that will show your child or grandchild just how much they mean to you. Here’s a suggestion, and one you won’t find in any stores: life insurance.
We know it may seem a little different in the gift department, but consider these reasons why life insurance can be just the right choice:
- At its most basic level, the purpose of life insurance is to indemnify you for the financial expenses of a child passing away. While there is another view that holds you should only buy life insurance to replace lost income, this ignores that there are economic losses incurred in addition to a loss of income. It has become standard practice to buy life insurance on non-working spouses when you have minor children, why should you not buy insurance on the children themselves? Consider the following: Final expenses can easily top $10,000 once factors such as casket, grave site, memorial, and funeral costs are factored in. Do you live in a place other than where you’d want your child buried? If so, have you factored this additional cost into the planning? Are you in a position to write a check for this? If not, how would you come up with the money if the unthinkable were to happen? While this may seem morbid, it is a reality that should be considered.
- Obtaining coverage while insurability is still there. What if you develop an adverse medical condition that makes coverage more expensive or not possible at all? Consider coverage now.
- Avocation factors such as being a private pilot or extreme sports. Both of these will affect rates and possible insurability if a policy is purchased as an adult. Insurers will even consider scuba diving to have an increased mortality rate depending upon how deep you dive. If coverage is bought on a minor, these types of activities are immaterial.
- It can last a lifetime—and then some. Permanent life insurance provides death benefit protection, creates a living legacy that will accumulate cash value with each passing year, and may help your child or grandchild get a head start on their financial future. Preferential tax treatment in that cash values grow inside of a policy tax free and death claims will be paid out tax free in most cases. There are limits to what how much you can pay in premiums into a policy and when you can pay in those premiums. Any policy that has too much paid into it becomes a Modified Endowment Contract (MEC) and loses some of its tax advantages.
- It won’t wear out or fall apart. Provided you continue to pay the policy premiums, the life insurance policy you purchase for your kids or grandkids today can still be there years from now—something that material things can’t provide.
- It has accumulation potential. Most gifts lose value over time. A permanent life insurance policy, on the other hand, has the potential to accumulate cash value each year. Cash values can be borrowed for any purpose—to provide a down payment on a first home, to help pay for college, to start a business or even to help fund a comfortable retirement years down the road. You can borrow against a life insurance policy’s cash value without a credit check or paying taxes but be aware that the loan might affect the policy’s longevity. Also, you can withdraw what you’ve paid in premiums tax free and pay income tax only on gains if you choose to surrender the policy.
- Premium rates may never be lower. Premiums generally increase with age, but with permanent life insurance, it’s possible to lock in the premium at the insured person’s current age – for life.
- This policy can help guarantee future insurability. Once the life insurance policy has been issued, coverage cannot be canceled as long as all required premiums are paid. Also, if a special rider is included with the policy, the person insured has a right to increase coverage by purchasing a new policy at designated dates, regardless of insurability.
Some Additional Details about Buying Life Insurance for Young People
- When a person insured is a minor, the life insurance policy is generally owned by the purchasing adult until the child reaches the age of majority as defined by state law. Upon reaching the age of majority, ownership of the policy can be transferred to the child.
- Once the child is an insured adult, he or she can select the beneficiary. Prior to that, the beneficiary is generally a guardian or parent.
- You have two choices regarding how premiums should be handled.
- First, you can take a lump sum (such as $14,000.00 which is equal to the annual exclusion for gift taxes) that could otherwise be given as an outright gift to the child or grandchild; instead, purchase a single premium life insurance policy for whatever face amount that sum buys. The advantage is that no further premiums are required.
- The second choice is to select the premium or death benefit desired. Then, make the scheduled premium payments. Please note: There may be gift tax consequences, since the premium is considered a gift to the insured.
- You take it as employee benefit if offered by your employer. Oftentimes, many employers offer a nominal amount for free or minimal cost and you will have the ability to buy a little more. There is little, if any, underwriting done on this type of coverage. Often, you have to proactively opt-in to this employer coverage, as it doesn’t automatically cover your children. Make sure that you have opted in!
- Life insurance comes in two forms: term insurance and permanent insurance. Term insurance does not build any cash value and only lasts for a fixed number of years, usually no more than 30 years, before it disappears. Term insurance is not sold on children as it would run out in their peak earnings years and also due to company pricing constraints – it costs more to underwrite and service a policy than a company could collect in premium. A whole life policy is a fixed-premium policy, meaning that the premium you are committed to pay has little, if any, flexibility. When premiums are paid into a whole life insurance policy, part of the premiums pay for the death protection (technically known as cost of insurance) and the other part of the premium is added to the policy’s cash value and invested on your behalf by the insurance company. The thought behind a whole life policy is that over time, there is more and more cash value in the policy so there is less pure insurance to buy as the insured becomes older and the cost of that insurance is more expensive. For instance, if I buy a $100,000 whole life policy on my one year old son there will be no cash value to start with but at age 30 it might have $30,000 in cash value, and at age 50 it might have $50,000 in cash value
In summary, the prudent, responsible thing to do is to carry some sort of coverage on your children. Insurance is the perfect way to protect against events with a low probability of occurring but with a devastating impact if they do happen. If you are on track for your retirement goals and find cash building up in your bank account, I’d encourage you to look at using a policy as an accumulation vehicle as well.