The logic of life insurance for children

By Russ Banham
Russ Banham is a Pulitzer Prize-nominated journalist and author of 26 books on business and management.
Posted on Sep 22, 2017

It’s one of the more difficult subjects for a parent to consider: Should you buy life insurance for your children?

On its surface, the notion is disturbing and a little morbid. Life insurance first and foremost is about providing a death benefit. And that prompts people to consider the consequences of the death of their child.

Then there are pragmatic considerations. Very few children, relatively speaking, die in the United States and no one depends upon them for economic support.

Yet, there are other important aspects of insurance for parents to consider. And they aren’t about death as much as helping your child with his or her future. Indeed, life insurance can be part of a long-term financial strategy that may provide significant economic advantages to the child later in life.

Future insurability

Permanent life insurance policies can include provisions, sometimes referred to as “riders,” that allow the insured to essentially increase his or her coverage over their lifetime. Such provisions, called guaranteed insurability riders or guaranteed purchase options, provide for the purchase of additional insurance at certain times in the future, regardless of any changes in health.

This could be important if your child experiences significant health issues as he or she ages. An illness would not preclude their ability to remain insured and even allow them to continue to purchase additional amounts of life insurance protection, depending on the life insurer and the product details.  

 “Say you buy a permanent life insurance policy on a child for [a face value of] $50,000,” said Kevin M. Lynch, an assistant professor of insurance at The American College of Financial Services, giving a hypothetical example of how such a provision would work. “Depending on the policy and the insurer, the child will be permitted at eighteen years of age or the legal age of consent in their state to purchase an additional $25,000 of life insurance, irrespective of his or her health. Three years later, the individual is given the opportunity to buy yet another $25,000 in permanent life insurance. The same opportunity might be offered to the person every three-year period thereafter.”

At each of these stages, the individual would not have to provide evidence of insurability and would pay the same premiums that a healthy person of the same age would pay.

“This can be especially useful in situations where a particular disease like diabetes, strokes or heart problems run in a family,” Lynch said.

Life insurance policies with these kinds of provisions typically cost more than policies without. On the other hand, health is a major factor behind purchasing insurance as an adult. It affects insurability for permanent life insurance purposes or may contribute to higher life insurance premiums. (Related: Life insurance quotes)

“By purchasing the insurance on a child, the future costs can be significantly lower in some circumstances,” said Lynch, who co-authored the book Fundamentals of Insurance Planning. “Assuming the policy premiums are paid up, the policyowner would not be required to undertake a medical examination at any time in the future to maintain the insurance. Young adults whose parents did not buy the insurance for them as children would be required to qualify for coverage by submitting to medical underwriting.” 

Future source of funds

Another reason why the insurance may make sense for some parents is the nest egg it builds for their children.

Permanent life insurance policies build cash value over time. This makes such policies more expensive than term life insurance policies, which simply provide a death benefit. But those insured under a permanent policy can borrow from the cash value for any reason without qualification. And while there is interest charged on the loan, there is no requirement to pay it back.  

Of course, there are consequences to taking a cash value loan. Interest on the loan builds until it gets repaid (or the insured dies). This reduces the death benefit and cash value and increases the chance that the policy would lapse, triggering a possible taxable event on the earnings. (Related: Life Insurance Calculator)

Nevertheless, for a parent hoping to provide help for a child to buy a house or repay student loans in the future, the cash value component of permanent life insurance can be an attractive feature. And, the younger the child is, the less expensive the life insurance policy is likely to be and the more time it will have to accumulate cash value.

In addition, the continuation of the life insurance policy over the years provides an opportunity for parent and child to discuss financial matters and consequences, especially as the time for signing over the policy approaches.

Financial pros and cons

Many financial planners see value in the idea of purchasing permanent life insurance for children, but caution that it is just one way to build financial value for children in the future. (Related: Find an advisor)

“No financial product, and we sell both insurance products and securities, is a cure-all, be-all, and end-all for a family’s planning needs,” said Dean Aita CFP®, president of Aita Financial Group. “It all comes back to the family’s objectives.”

He explained that a family wanting to build up a college savings fund for a child or to pay for the individual’s wedding in the future are objectives that merit a discussion of the most advisable investment strategy.

“In such cases, I would recommend securities — stocks, bonds, mutual funds, and so forth,” said Aita. “The potential returns, minus your costs to have the account, are historically better than many other alternatives. These funds are also liquid and available, despite the substantial risk of loss of principal at any given time."

“On the other hand, if the parents point out that the family has a horrific history of medical issues and they’re worried about the child’s future insurability for life insurance purposes, that would certainly warrant a close scrutiny of life insurance,” he added. “Life insurance should never be touted as a great savings vehicle on its own; it should augment what families are doing with other investments. The more important premise is to create an estate.” 

Others, like Lynch, view life insurance as a component of a highly diversified portfolio of assets, allowing for a more balanced investment approach.

“Permanent life insurance [that offers guaranteed cash value] represents what I call the 'safety portfolio,’” he explained. “With permanent life insurance over a period of time, the cash values that build up are not `iffy’ like a stock. They’re guaranteed.”

The expense of loss

Of course, devastating as it might be, there are expenses to consider in the loss of a child or any family member.

The National Funeral Directors Association tabulates the cost of a funeral and burial at a median $7,181, in 2015, the most recent data available .1 If a vault is required, the median expense rises to $8,505. The association represents more than 10,000 funeral homes in the U.S. and 39 countries around the world.   

“Even for parents who have the means to pay for these unexpected expenses, the insurance proceeds can be used to absorb additional costs, such as for family counseling or for unpaid time away from work,” Lynch said. “For others without significant financial means, the income [from the insurance proceeds] can offset the possibility of going into debt to pay for these various expenses.”

Certainly, parents of a newborn should consider these various pros and cons in making a decision that is right for their particular circumstances. Although contemplating the death of a child is horrific for most people, such shattering events do occur. Similarly, diseases and other health issues happen to young people, affecting their insurability for permanent life insurance purposes.

The bottom line is that permanent life insurance is one of several financial tools available to offset the bad things that occur in our lives and businesses. With regard to permanent life insurance with a guaranteed insurability option, this feature, in addition to the customary death benefit, may provide a financial cushion for children well into their adult years.

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National Funeral Directors Association , “2015 Member General Price List,” Oct. 1, 2015.

The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own, and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.