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Monday, April 30, 2012

Should you buy life insurance for your kids?

Is it financially smart to buy life insurance for your child, and if you do, should you buy the type with a savings vehicle?

If you have kids, or are expecting, you have most likely received ads in the mail for life insurance for your child (i.e. Gerber Life Grow-up or Life College plan). Many of these plans tout a savings vehicle in addition to the life insurance. This is a big selling point for these plans as they push the savings piece as an added benefit, a "how can you go wrong?" type of product. Does your child need life insurance? Is it giving them a head start in life? Is the savings piece worth it?

Why would you even consider life insurance for your child?
Here's the sell: "Give your child (particularly your newborn) a financial head start in life! The premiums are cheap and you are guaranteeing your kid's future insurability to boot! You have enough to worry  about as a new parent, so give yourself some peace of mind. Now your baby can be covered regardless of an unfortunate illness and in the worse case scenario you will have the cash to cover final expenses. The best part? If you buy a whole life policy, and your child grows to be a strapping healthy lad or dame, they will have access to the cash value in the future! How can you go wrong?"

How you can go wrong.
First, the purpose of life insurance is generally a salary replacement tool to provide security for one's dependents. So unless you have the Gerber baby itself, whom is providing income for your entire family, baby life insurance doesn't fit that definition. The Consumer Federation of America (a consumer advocacy and education group), along with many financial planners in the industry, believe that its almost never a smart financial move to purchase life insurance for your kids. I don't even recommend life insurance to adults unless they have dependents; so I definitely would not recommend life insurance for those dependents, especially if you are not meeting other important financial goals.

Second, the amount of these kid policies are usually quite low (typically $5,000-$10,000). This amount will not be enough as a salary replacement in the future, and many times you can't increase this amount as they get older if they do indeed have a chronic illness.As of today, the maximum you can purchase under the Gerber life plan is still only $50,000 which will not be much especially in 20+ years. They state that the coverage automatically doubles once your child turns 18, but once again, even $100,000 of coverage in 18 years will not be much when you take inflation into account.

Finally, what about the savings piece? In general, insurance policies are not good savings vehicles regardless of who is the insured. These policies not only have steep hidden costs, but they also provide you with minimal return on your investment. If you are going to invest money for your child's future (education for example), do it in a 529 account, not an insurance policy.

The Takeaway
If you have dependents, obtain life insurance policies (preferably term) for you and your spouse (particularly the breadwinner), contribute 10% of your gross income to your retirement accounts, 6-9 months of expenses in an emergency fund, and then do what you can in a 529 for your kids' education. The key is to make sure you are protecting your kids in case something happens to you, but also protecting your future so your kids don't spend money taking you in down the road!

Once all this is taken care of and you still want to open a policy for your kids, do your research, look into your employer's benefit package (many times you can supplement your own policy with juvenile insurance for pennies a month) and do not opt for a insurance/ savings vehicle combo.

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