There are a million things to think about when welcoming a new baby into the family, but there’s one item parents and grandparents almost always overlook: whole life insurance for children.
Whole life insurance for children is one of the most secure, guaranteed ways to help your child build wealth and can give them significant advantages in adulthood to set them up for financial success. In this article, we’ll explain the benefits of whole life insurance for children, types of whole life insurance you can buy for kids, and how to find the best policy option for your budget.
BENEFITS OF WHOLE LIFE INSURANCE FOR CHILDREN
Like all life insurance, whole life insurance for children provides a death benefit if the insured child passes away. This can help with funeral costs or allow parents to take time off work to grieve. But the primary reason to purchase a whole life insurance policy on a child is to accumulate tax-advantaged wealth starting at an early age.
When it comes to accumulating wealth a child can access in adulthood, whole life insurance provides 6 unique benefits not found with other financial tools or investment options:
#1. Certainty: Whole life insurance for children (and adults) comes with a guaranteed rate of return. This can help you plan accordingly for future events in your child’s life like college, a wedding, or purchasing their first home. These financial milestones can be budgeted for knowing exactly how much a child’s policy will earn year over year.
Whole life insurance also comes with guaranteed level premiums — whatever rate you pay when you insure your child now will be the rate you pay for their entire lifetime. Insuring your child while they’re young can guarantee the most affordable whole life insurance coverage for life.
#2. Protection: Unlike market-based investments like stocks or bonds, whole life insurance isn’t subject to market volatility. It allows you to invest in your child’s future without the worry of a market downfall destroying accumulated wealth.
Further, whole life insurance guarantees your child will have insurance coverage for their entire lifetime — even if they develop a health condition or pursue a career path that would make it more difficult (and more expensive) to find insurance. It protects their insurability from the unexpected.
#3. Control: A life insurance policy for your child is a private contract between you and your insurance company. In most states, it isn’t subject to judgements or creditors.
#4. Liquidity: Whole life insurance policies are liquid, meaning you can access your cash value at any time. There are a few ways to do this and some have more tax advantages than others (more on that later), but the bottom line is this: If you need funds for any reason, they are accessible to you and/or your child.
#5. Cash Flow: In addition to being liquid, whole life insurance policies can provide steady cash flow via earned interest (and potential dividends). Typically, using life insurance for cash flow will deplete the death benefit, but if the goal of the policy is to provide your child with some sort of income over a period of time (like for their own retirement), it serves that purpose extremely well.
#6. Generational Wealth: A primary goal of many parents is to pass down wealth to their children. Whole life insurance policies for children are ideal for this purpose because of the many tax advantages and the fact that properly structured policies can help a parent avoid gift taxes and/or estate taxes, especially when policies are purchased in a trust.
HOW IT WORKS
Curious to learn more about how whole life insurance for children works? Here are some of the most commonly asked questions about policies for kids:
Q. Who can buy a life insurance policy for a child?
A. Parents may buy whole life insurance for children directly related to them. This includes adopted and step-children, and sometimes foster children. Legal guardians are also allowed to buy life insurance for children. Grandparents may purchase insurance on their grandchildren, provided they have the consent of the child’s parent or legal guardian.
Q. How do whole life insurance policies for children accumulate cash value?
A. When a policy premium is paid, a portion goes toward paying for the death benefit and administrative costs of the policy. The remainder is credited to a built-in savings component called cash value. Cash value in a whole life insurance policy earns a guaranteed rate of return determined by your insurance company.
Should you opt to purchase your child’s policy through a mutual insurance company, it is considered a ‘participating’ policy and is also eligible to earn non-guaranteed dividends (usually tax-free). The nation’s top-rated mutual insurance companies we work with at Paradigm Life have historically paid dividends for over 100 years.
Q. How do policy loans work?
A. The policyholder can access the cash value of whole life insurance via tax-free policy loans at any time. Policy loans are subject to a low interest rate determined by your insurance company, but you determine the payback schedule. Many whole life insurance policies continue to earn interest on the full cash value of the policy, regardless of any outstanding policy loans. This offers a huge financial advantage compared to other savings vehicles or interest-earning investments.
As the policyholder, you can access this cash value as part of your private family bank. If you transfer ownership of the policy to your child in adulthood, it’s theirs to access as they choose. Any policy loans outstanding after the death of the policyholder will be deducted from the death benefit, plus interest. If the policy terminates while the policyholder is still living, there may be additional tax implications.
Q. What’s the difference between a policy loan and a withdrawal?
A. Policy loans are tax-free, but are charged a low interest rate by your insurer. They do not affect the death benefit of a policy unless they are unpaid when the policy terminates.
Withdrawals are taxed if the withdrawal amount exceeds the amount paid in premiums and usually decrease the policy’s death benefit.
Q. What happens to my child’s policy when they reach adulthood?
A. When your child reaches adulthood, ownership of their whole life policy may be transferred to them and they are responsible for paying policy premiums. Some policies also have a purchase option that allows your child to add additional coverage without the need for a medical exam.
Alternatively, the policyholder (parent or grandparent) can continue to own the policy or transfer ownership to a trust, paying premiums and authorizing policy loans/withdrawals on the insured’s behalf. Some parents/guardians choose to structure policies so they are completely paid up by the time a child reaches adulthood.
Q. Who is the beneficiary of my child’s policy?
A. The beneficiary of a life insurance policy can be anyone you choose, but typically you are both the beneficiary and the policyholder while your child is still a minor. Should you transfer their policy to them in adulthood, they can name a beneficiary of their choosing, like their spouse. Should you choose to retain the policy in adulthood, you can remain the beneficiary or transfer the policy to a trust, where the trust itself is named beneficiary.
Keep in mind there are three parties involved in an insurance policy: the policyholder, the insured, and the beneficiary. If the three parties are three separate entities, there may be tax implications down the road. Speak with a Wealth Strategist for details.
Q. What happens if I decide to cancel my child’s policy?
A. If you decide to cancel your child’s policy, or your child decides to cancel it in adulthood, you have the option to surrender it to your insurance company. They will typically pay out the cash value of the policy, minus any surrender fees (usually applicable in the first 10 years of a policy). Any gains may be taxed.
Q. How much is a whole life insurance policy for a child?
A. Premiums for whole life insurance for children vary, but are at their absolute cheapest when your child is still a baby. You can insure a child as young as 15 days old. Premiums are based on age, health, and coverage amount. Regardless of when you choose to insure your child, you’ll lock in your premium for the duration of your child’s lifetime.
On average, premiums for healthy children under age 5 run about $40/month for $100,000 of coverage (for life). For comparison, $100,000 of whole life insurance for a healthy 20-year-old male may easily be around $100/month. There are significant long-term savings involved when you insure your children while they’re young.
Q. Will my child need a medical exam?
A. Medical exam requirements vary by insurer but usually a medical questionnaire is sufficient. Your insurer will ask detailed questions about your child’s health to determine insurance eligibility. It is rare for a child to be denied insurance coverage.
Q. What if my child has an illness or disability?
A. It’s still possible to get life insurance coverage for children born with special needs or certain chronic illnesses. In these instances, insurance companies may provide coverage on a graded scale.
Q. Can I buy term life insurance for my child?
A. No, term life insurance is not offered for children. The closest thing to term life insurance you can purchase for your child is a child policy rider.
WHOLE LIFE INSURANCE FOR CHILDREN VS. CHILD POLICY RIDER
In some instances, whole life insurance for children is too expensive. This may be especially true for young families and parents in the early stages of their career. Fortunately, there is another option: a life insurance child rider.
A child rider is a type of supplemental insurance purchased in conjunction with a parent’s whole life insurance policy. One rider will insure all minor children in the family—both now and in the future. Once a child reaches adulthood, they have the option of converting the rider to a whole life insurance policy of their own without needing a medical exam or other proof of insurability. Each child covered under the child rider will have this option.
Unlike a whole life insurance policy for a child, a child rider isn’t permanent and doesn’t earn any cash value. If the option to convert to a whole life policy in adulthood isn’t exercised, the rider expires for the child in question and they will no longer have coverage.
Child riders usually provide minimal coverage, around $10,000, which isn’t enough for an adult anyway. It’s essentially a placeholder that provides a small death benefit to parents in case their child passes away and the family needs to cover funeral costs. But at an average cost of just $50/year, it’s an extremely affordable way to guarantee your child future whole life insurance eligibility and the option to purchase more coverage down the road.
WHAT TO KNOW BEFORE YOU BUY
As the airline safety brochure says, secure your own mask first before securing your child’s. The same is true of life insurance. Before you buy life insurance for your children, it’s critical to have sufficient coverage for you and your spouse. If something were to happen to you, there isn’t anyone to pay your children’s life insurance premiums and their policies would lapse. In fact, most insurance companies won’t allow you to buy a whole life insurance policy for a child unless you have one on yourself first.
If your budget doesn’t currently allow for each of your children to have their own whole life insurance policy, consider adding a child rider onto you or your spouse’s insurance policy instead.
If you decide a whole life insurance policy is part of a financial strategy that suits your child/family, you’ll need to determine how much coverage you want and how you want to pay your premiums. Depending on your budget, it may be best to pay premiums annually or monthly over the course of your child’s lifetime. Perhaps you’d like to make sure your child’s policy is paid-up by the time they reach adulthood. A Wealth Strategist at Paradigm Life can show you insurance illustrations based on your family’s financial needs so you can see your options and outline a strategy that works to achieve your goals.
Schedule a complimentary consultation with a Wealth Strategist today, and start your child on the path to financial security with a whole life insurance policy or child rider. Your family’s goals are our goals, and we’re with you every step of the way.