The thought of buying life insurance for a child may seem grim. But some financial experts say buying a policy for a child or grandchild and allowing the money to build up over decades can provide a financial cushion when the child's retirement eventually rolls around.
"It's kind of a gruesome idea to buy insurance on a child. It's almost like bad luck," says Rich Arzaga, principal at Cornerstone Wealth Management and a professor at University of California, Berkeley. "If you get past this emotional bias, you leave them a legacy they would not have."
Jean Towell, a spokeswoman with Northwestern Mutual Life Insurance Co., says buying life insurance for a child provides "a long-term asset that gains value over time."
The policy ultimately could be worth hundreds of thousands of dollars – or more – depending on factors such as the type of life insurance policy you buy, how well the insurer's investments perform and how long the child hangs on to it.
Children typically don't have to undergo the underwriting process, although a few simple medical questions may be asked. Purchasing a policy when the child is young generally means that as long as the policy never lapses, the child will always be able to get life insurance – even if he or she switches the type of policy when older – without having to go through medical underwriting, Towell says.
Greg Blake, executive director of life insurance products at USAA, says there are three main types of life insurance to choose from when insuring a child:
A permanent life insurance policy continues on indefinitely. The other two types of life insurance policies can be converted to permanent insurance once a child reaches adulthood, but the life insurance rates will be higher at the time of conversion because premiums increase with age, Blake says.
Life insurance companies generally offer children's policies in small sums, such as $10,000 or $25,000, and topping out at about $100,000. However, the amount often can be increased when a child reaches certain ages in adulthood, Blake says.
Andy Hutchison, Mutual of Omaha's vice president for product development, says buying life insurance for a youngster is becoming increasingly popular among baby-boomer grandparents because it gets their grandchildren "started in life, from a financial standpoint."
If a parent or grandparent buys a policy for a child, someone – such as the child or the person who purchases the policy – needs to continue to pay the premiums once the child reaches adulthood in order to keep the policy in force, says Ray Caucci, vice president of product management at Penn Mutual.
Along with providing a death benefit to survivors when the insured dies, the life insurance policy has a cash value. A child who keeps the policy into adulthood can take cash out of it to fund a college education, a new small business or a wedding, Caucci says.
The owner can borrow against the policy and may – or may not – choose to pay the money back. Borrowing against the policy and not paying the loan back will decrease the policy's cash value and death benefit.
If your children hold on to their life insurance policies, the policies will continue to grow on a tax-deferred basis. A child can decide later whether to cash it in or borrow against it to help supplement retirement income.
Hutchison says one possibility is to convert the insurance policy into an annuity at retirement age so it can generate a set amount of income each month. Monthly income from the annuity would be based on the value of life insurance policy and the owner's age.
When buying life insurance in order to eventually supplement a child's retirement, it's important to choose a company likely to still be around 60 or 70 years from now, Blake says. Before you buy, "evaluate the financial strength of the life insurance company" by checking the company's rating from an agency such as A.M. Best, Blake says.
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