If you recently had a baby, or are planning to have one in the near future, then the thought of taking out a life insurance policy may have crossed your mind. Wanting to protect your loved ones is a natural instinct, especially your children.
A life insurance policy in a parent's name, with the child as the designated Beneficiary, is a common scenario. But what if that was switched around? Although it's less common for parents to take out a life insurance policy in their child's name, it's not unheard of. Trust & Will explores the pros and cons of taking out child life insurance.
The Significance of Life Insurance
Life insurance is a contract between an individual and an insurance company, where the insurer agrees to pay a designated Beneficiary a sum of money upon the death of the policyholder, in exchange for premium payments.
The core purpose of life insurance is to provide financial security and peace of mind to the insured individual's Beneficiaries. People take out life insurance policies for a variety of reasons, such as covering funeral expenses, repaying debt, providing for their dependents, and ensuring financial stability for their loved ones in the event of their untimely demise. It can act as a financial safety net, helping families maintain their lifestyle and meet their financial obligations even after the loss of a primary earner.
When purchasing a life insurance policy, the premium is typically determined by a number of factors:
The policyholder's age and gender, with premiums generally increasing as the policyholder ages.
The health history of the policyholder, including current health status, medical history, and any pre-existing conditions.
Lifestyle choices, such as smoking or engaging in high-risk activities, can significantly affect premium costs.
The term length of the policy, with longer terms typically resulting in higher premiums.
The amount of coverage desired, as higher coverage amounts lead to higher premiums.
The type of policy chosen, as whole life insurance usually has higher premiums than term life insurance due to its cash value component and lifelong coverage.
What is Child Life Insurance & How Does it Work?
Child life insurance is much like adult insurance. It's a contract made between an individual and an insurance company. Typically, the parent acts as the Beneficiary and would receive financial compensation if the child were to pass away. The payout could help cover costs such as end-of-life expenses.
There are generally two ways to obtain life insurance for a child:
1. Standalone Child Life Insurance Policy: This option involves a parent, grandparent, or legal guardian securing a life insurance policy specifically for the child. Often, these policies are of a permanent nature, such as whole life insurance, ensuring coverage throughout the child's lifetime. A notable feature of permanent life insurance is its ability to accumulate a cash value over time, which the child can access as they mature, providing a financial resource in adulthood. Typically, these policies offer death benefits of about $50,000. Responsibility for premium payments falls to the adult policyholder until the child reaches a legally defined age of independence—commonly 18 or 21 years, subject to the terms set by the insurance provider. Once the child becomes an adult, the obligation to maintain premium payments shifts to the insured individual to maintain the policy.
2. Rider Addition to an Existing Adult Policy: Certain insurance companies offer the option for an adult policyholder, such as a parent, grandparent, or guardian, to attach a child as a rider to their current term life insurance policy. Upon reaching adulthood, complete ownership of the policy is transferred to the now-adult child. This arrangement gives the grown child the option to transition the term life policy into a permanent life insurance policy, ensuring lifetime coverage. They would have to continue making premium payments.
This article will focus on the standalone policy for a child.
According to Progressive, you can take life insurance out for your baby as soon as 0 to 14 days old. You can enroll them easily, especially as a medical exam is not required to qualify them for coverage.
Understanding the Pros & Cons of Child Life Insurance
The topic of child life insurance is controversial, and if you're considering purchasing a policy for your little one, then it's paramount that you understand the arguments for and against it. It's important to look at some of the facts when facing such an emotionally-charged decision.
Possible Advantages of Purchasing Child Life Insurance
The child life insurance market exists for a reason -- there are advantages and benefits that a family can gain from purchasing a policy for their child. Here are some examples:
Financial Protection: One of the core reasons parents consider life insurance for their children is the financial protection it can provide in the unfortunate event of their child's death. No parent wants to imagine a scenario where this would be necessary, but for some, the peace of mind in knowing that funeral and burial costs would be covered can be significant.
Future Insurability: Another benefit of taking out life insurance at a young age is to secure future insurability. Children typically have little to no medical history, meaning you can secure a life insurance policy at a low cost. Additionally, in the event they develop a health issue that would otherwise make them uninsurable, they’ll already have coverage in place.
Cash Value Accumulation: Certain life insurance policies, such as whole life insurance, build cash value over time that can be employed for various purposes, like education funding or a down payment on a home. This can offer both a matured benefit for the child and cash resources for the family if necessary.
Exploring the Cons of Child Life Insurance
Some experts such as Dave Ramsey argue that child life insurance is basically a marketing ploy that is "aimed at selling you something neither you nor your child actually need." Here are some possible reasons to decide against child life insurance:
Cost Considerations: Life insurance policies can be costly and can vary in price substantially. While securing an insurance policy early in life generally guarantees lower premiums, considering the cost over the life of the policy is essential to ensure it's a sound investment. Ramsey argues that a young adult should be able to purchase their own life insurance policy, still at a low cost, in their 20s and 30s.
Opportunity Cost: While child life insurance premiums are less costly than those for adults, it's still an expense to consider. Those premium payments could instead be placed in a savings account or Trust account for your child.
Limited Coverage: Most insurers will limit the coverage amount for child life insurance to about $50,000. While this may be a helpful sum while the child is still small, it likely isn't a sufficient amount once they reach adulthood.
Premium Must Be Paid: While you may love the idea of taking out an insurance policy for your child as a gift, know that they take on the responsibility of the policy once they reach adulthood. In order for them to maintain the policy, they must continue paying the premium. This may turn out to be more of a financial burden than they would have liked.
Alternatives to Consider
Purchasing a life insurance policy for your child can be worthwhile, but there are some notable drawbacks upon looking through the fine print. In most cases, an insurance company will limit the coverage amount to around $50,000. Really, these policies are designed to help cover end-of-life expenses, including medical, burial, and funeral expenses. Further, this coverage is insufficient as the child matures and later needs to provide for their own loved ones.
If you are concerned about covering unexpected costs, know that there are other alternatives. For example, you could build up an emergency fund, put money into a college savings plan, or transfer assets into a Trust.
What we would hope for any parent is that they will never have to plan their child's funeral. Instead, we hope that you would need these funds to cover the cost of braces. These alternatives provide a lot more flexibility for a growing family and the unlimited number of scenarios that could happen.
Trust & Will: The Better Way to Protect Your Loved Ones
What do we recommend?
Prioritize buying life insurance for yourselves first. If your budget allows, add your child to your own policy as a rider. These costs are much more affordable, typically under $100 per year. That way, your whole family is covered if anything were to happen.
In addition, consider allocating your resources toward an estate plan. Your underlying intention behind purchasing a child life insurance policy is to protect your child as best as you can. Ironically, a child life insurance policy is more about providing you with some financial insurance if they were to pass away. Instead, an estate plan is a powerful way to protect your loved ones to ensure they are provided for if anything were to happen to you. Of course, a life insurance policy in your name, with your loved ones as the Beneficiaries, is a strong building block of a comprehensive estate plan.
At the end of the day, child life insurance is a deeply personal decision that shouldn't be made lightly. While the financial benefits can be compelling, parents need to consider the full picture, including the costs, alternative investment strategies, and their own comfort with the idea. By being well-informed and considering all aspects thoroughly, parents can make the decision that aligns with their family’s needs and values.
At Trust & Will, we’re here to help keep things simple. You can create a fully customizable, state-specific estate plan from the comfort of your own home in just 20 minutes. Take our free quiz to see where you should get started, or compare our different estate planning and settlement options today!
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