Written by: Peggy Haslach
A few months ago, I wrote a piece on the Gender Gap in Life Insurance and stressed why it is vital for female doctors and other licensed professionals to get Life Insurance. Since I wrote that article, our world has turned upside down, and we are getting hit by a global pandemic and a financial downturn. We still have a long way to go before this is over, and one of the lessons families are learning is that we're not prepared for a healthcare crisis or an economic downturn, let alone both.
This pandemic proved the importance of life and disability insurance for our healthcare professionals and their spouses. In this piece, I want to address why it may also be smart to purchase Life Insurance for your children (they are often called "Kiddie Policies").
Before we get into why one would buy Life Insurance for a child, let us acknowledge that very few Life Insurance companies will allow you to purchase life insurance on a child if the parents are not insured. In fact, you cannot buy a standalone Term life policy for a child. Usually, the only way to get a Term Policy for a child is to add it to their parent or guardian's policy. So if you are reading this article and think adding insurance for your child is a good idea, be prepared to talk about adding coverage on yourself and your spouse if you have not done that already.
Term vs. Permanent
A Term Life Insurance Policy only covers the death benefit for a stated period (or term). A Permanent Life Insurance Policy can last your whole life and will allow you to save when the policy increases in cash value. Whole Life Insurance is a type of Permanent Life Insurance, as is Universal Life, Indexed Universal Life, and Variable Life Insurance.
Over the years, there has been a debate between advisors over what type is better, term, or the various types of Permanent. We are not going to go into that debate in this article. What they do agree on is the fact that most adults need some amount of life insurance. Some struggle with the reasons why Life Insurance makes sense for children is that there are other ways to protect children financially.
On the one hand, I agree, the speed in which cash value accrues in a Life Insurance Policy will not allow you to save at the same rate of return as a 529 or ROTH IRA. On the other hand, I believe that though the cash value may accrue at a slower rate, there are guarantees and living benefits that some Life Insurance policies offer that you cannot get from investments. I also do not believe it has to be an either/or; it can be both. If you were to go the route of adding a Term policy to your policy, I would suggest also setting up a 529 or other savings account for your children.
Tax-Deferred Savings & Tax-Free Payouts to Beneficiaries
Another benefit of a Permanent Policy is savings in the policy grows tax-deferred, and any money taken out of the policy in the form of withdrawal or surrender is not taxed as long as the amount received is less than the amount of premiums paid into the policy. Also, as the policy owner, you can borrow against the policy in the form of a policy loan. Please note loan provisions vary, and some policies have surrender charges if you should cash in any portion of your policy during the first few years.
The low cash value growth and the cost of fees to maintain a life insurance policy are the main reason why many advisors will recommend that their clients forgo the Life Insurance and save with a 529 or other college savings strategies. Despite that, slightly more parents and grandparents purchase life insurance for their children and grandchildren than do those that set up 529 plans.
So why would people choose the slower accrual over the higher return? There are a few reasons for this. First, money taken out of the 529 can only be used to cover secondary education expenses. If you use it for anything else, the funds withdrawn will be subject to taxes and penalties. Second, it takes time for the money to accrue. Some families will seed the account with gifts from a family member, but most families start a 529 plan by making small monthly payments. When they hit a tough patch, they stop contributing. We saw this happen during the downturn of 2008 and 2009. We will probably see it again this year.
Making matters worse is that once the families stop contributing, it takes a while before they are ready to start up again. If you stop paying into a 529 plan or other investment, the funds that are in the account will ride the ups and downs of the market like your other investments, so your account value may grow but not nearly as fast as it would if you continued to contribute to the account.
Most people who buy life insurance think of the premium as a payment, not investment or contribution to savings. With life insurance, once you start paying into a Life Insurance policy, the full death benefit is available if the child should die. And in some cases, there are also living benefits available if the child becomes chronic, critically, or terminally ill. If you stop paying into a Life Insurance policy, you could lose the death benefit in that the policy could lapse. In other words, if you purchased a policy for your child today (made one premium payment), the death benefit would be available if your child died tomorrow. And yes, that does mean that if we do have another wave of the Coronavirus, you could cover have coverage in time.
Many advisors who argue that there are better ways to save are quick to dismiss the idea of purchasing Life insurance for a child because they say it is easy to get a policy when they are 20-30. That is if they are healthy. A child who develops a medical problem at a young age may not be able to qualify for insurance later in life. This is one of the reasons that most people buy a policy for their child. Their own life experience of surviving cancer, being a smoker, walking away from an accident, having in a high-risk hobby policy, or being exposed to COVID-19 proved the value of having a policy. If they can get a policy later in life, they know they are going to pay for it and sometimes dearly.
It is much less expensive to purchase a policy when your children are younger and have had fewer life experiences. Many policies will also allow you to add a rider (optional benefit) that will guarantee the insurability for the original policy and additional death benefits placed on the policy. So buying a base policy is an inexpensive way to make sure your child has some coverage now and add to it later when they turn 20-30.
Provides Money to The Family
Many other advisors claim that statistically, the odds of a child dying or getting a rare disease are slim. They say that it would be better to stash money into an emergency fund. Again, I think this does not have to be an either/or situation. Emergency funds get used for all sorts of emergencies that can happen anytime. The funds are used for everything from car repairs to covering the rent/mortgage when we close the economy. If you are a doctor fresh out of medical school and have a boatload of loans, it is going to take a while to build up those emergency funds. The cost of one medical emergency or death of a family member, even if you do have health insurance, can wipe out savings and can be financially devastating to a family.
One of the things this crisis has proved is that people have not saved enough to cover a stay at home order, let alone with the cost of covering the care they might need if they or one of their family members get sick. These days, most life insurance policies have living benefits that will help alleviate the cost if the insured becomes critically, chronically, or terminally ill. So, if you have a policy and you get critically or terminally sick, you can tap into the death benefit to cover your care. But, if your child gets chronically, critically, or terminally ill, you cannot use your policy to cover them. However, if they had a policy, you could use theirs to cover those costs not covered by your healthcare plan.
Hindsight is 2020
Yes, life will be different, moving forward. No one ever expected to see what we have seen over the past three months. And no one knows how the next big life event will affect us. One thing we do know is that there will be more events like these. We need to plan, so our family has financial flexibility now and for what the future holds.
Disclosure: Guarantees are backed by the claims paying ability of the issuing insurer.