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Should I buy Whole Life Insurance for my Children?

life-insurance-for-children

A reader, Arlene, recently asked a question in my article “investing on behalf of kids” about obtaining “Whole Life Insurance” for their young children.  A financial planner suggested that obtaining permanent insurance for their children is a good idea to invest in their future.

Here is the question:

Hello! A financial planner thinks it’s a good idea to get whole life insurance policies for our three children, each $100,000 policies. Is this a good idea? I know this doesn’t necessary pertain to their education future however it is still in regards to their future and I’m really struggling to know if this is a good path to take.  We will be paying $1500/yr per child for twenty years.

After that we no longer have to pay into the policy and the policy itself keeps growing and compounding. If they don’t touch it all their life and they go to retire they will each have around one million dollars to use. I just don’t know if these whole life insurance policies are legit or if they should be avoided? I am definitely not a financial expert like some of you in here, I’m a stay at home mom trying to make the right decisions for my kids. Any insight would be appreciated!

Background

First lets start with a little background for new readers – what exactly is whole life insurance? In terms of life insurance, there are basically three types: Term Life, Whole Life and Universal Life.

Term insurance insures an individual for a chosen number of years (which is the term).  For example, our family has purchased Term 20 insurance which means we have coverage for 20 years, with a pre-determined death benefit and set premiums paid annually.  At the end of the 20 years, we can either apply for new coverage, renew our current insurance for another set number of years (without medical proof), convert our coverage to permanent insurance, or stop coverage altogether.  Term life insurance is known as the lower cost insurance of the bunch.

Universal and Whole Life insurance, on the other hand, will pay a death benefit when you pass away regardless of when it happens (ie. not based on a term).  The other major difference is that Universal and Whole Life premiums are MUCH higher.  This is because in addition to providing life insurance, there is an investment portion of the product.  While the investment portion can grow tax free within these policies, they are also subject to very high fees (MERs).

Why Buy Insurance at All?

In my eyes (and many others), insurance is all about mitigating financial risk.  To mitigate against the cost of a major fire or flooding within your home, you buy home insurance.

If you need regular income to pay the bills, then you can mitigate against disability through disability insurance.

If other people (like your children) depend on your income to support expenses and would cause hardship if you were to pass away, then you buy life insurance.

Buying Whole Life Insurance for Your Kids?

So back to the situation at hand, should Arlene follow her financial planners recommendation to buy whole life insurance to insure her three young kids?

To sum up my thoughts – Not a chance.

As I mentioned, insurance is to mitigate against financial risk.  The only real financial risk when it comes to her children passing away is the cost of the funeral when they are young.  If this cost is a real concern, they can purchase a cheap term insurance to cover potential funeral costs (some providers offer $20k death benefit for around $30/year).

If Arlene does purchase whole life for her kids, once they are old enough, the insurance policy would be likely be assigned to a new beneficiary – like the child’s future spouse and/or children.

The argument that whole life and universal life insurance is a great retirement product is simply not true.  Even if the child accumulates a large sum within the investment portion of the  insurance policy, the child cannot simply withdraw the amount.  The investment portfolio can only be used to pay the premiums (which will no long exist after 20 years), or used it as collateral for a loan from the bank.

Mind you, I really don’t know a lot about Arlene’s situation so I’m making the assumption that her children are financially dependent on them.  If her kids are child TV stars and generating a lot of income to support the whole family, then maybe some insurance would be prudent.  Another reason why it may make sense to insure children is for future insurability reasons.  That is if Arlene anticipates that her children will have issues obtaining life insurance due to a future medical condition.

What Should She Do?

So it appears that Arlene wants to do something for the future of her children and I can relate with that.  What can she do instead of purchasing whole life insurance?  Here is what I would do:

  1. Start or maximize an education fund for the children.  In Canada, that would be an RESP, with the government adding 20% to your contribution up to $500.  In other words, if you contribute $2,500/child/year, then the government will add $500/child/year to your RESP account.  I would pick this option over whole life insurance for children any day of the week.  We opened a family RESP with TD using their e-Series index mutual funds.
  2. Consider an informal in-trust account.  If the RESP’s are maxed out, the next thing I would consider is to open an investment account on behalf of the children – an informal in-trust account.  This account can be turned over to the child once they reach the age of majority, which could be used for life milestone expenses like a wedding, down payment on a first home, graduate studies, or even a dream trip. There are a few considerations (taxation and portfolio selection) with this account which can be read here.

It would cost Arlene and her spouse a total of $4,500/year (for three children) for 20 years for a $100,000 death benefit (each) that doesn’t adjust to inflation and a high fee investment portfolio (that’s not really accessible).

Can she do better?  I believe so.  Assuming that RESPs are already maxed out, investing the $4,500 annually  in an informal in-trust account invested in a low cost indexed portfolio (assuming 5% return) would result in $168k after 20 years.  Let the account grow for another 20 years, and now the account is worth $445k ($1.18M after 40 years) with the added bonus that it is 100% liquid.

I can’t say that whole life insurance doesn’t have a place out there.  I can see some benefit to adult wealthy people who have all of their own accounts maxed out (RRSP, TFSA, RESP, mortgage paid off), have dependents, and looking for more tax deferral (and perhaps a way to pay off large capital gains tax upon passing).  However, this may benefit only very small percentage of the population.  Most people are better off buying lower cost term insurance and investing the rest with the goal of eventually becoming self-insured through your own accumulated wealth.

Final Thoughts

Whenever I hear these stories about recommending big insurance for children, my “rip off” alarm tends to sound.  It may sound a little harsh,  but whole/universal life insurance products are generally overpriced products that only benefit a very very small percentage of the (adult) population.  What makes it worse is that there is a conflict of interest as insurance agents are paid a higher commission selling whole life/universal life insurance rather than selling the more sensible term life insurance.

Moral of the story?  Avoid whole/universal life insurance for children; invest in their education instead.  If you’ve already maxed out their education fund, consider an informal in-trust investment account (available at most discount brokers) and invest the premiums in a low cost portfolio.  When the children become adults and require their own insurance, they can purchase lower cost term life insurance to help financially protect their dependents.

Thoughts, comments, or arguments?

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FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 26 comments… add one }
  • Cold Truth November 7, 2016, 10:03 am

    I think it’s time for some new legislation the the Certified Financial Planner and Financial Advisor certifications. I’d like to see a law that eliminates the conflict of interest in the system, because the current system puts the public at risk.

    At the very least the advisors compensation can’t be tried to the type of product they are recommending. Ideally, I’d like to see advisors compensated based on their time (like a lawyer). In the current system, they’re not much better that the proverbial ‘used car salesman’.

    People (mistakenly) trust these advisors to have their best interests at heart, and while I’m sure there are a few advisors that really try to do that, it doesn’t matter, the commission structure still creates a conflict of interest.

    • Steve November 9, 2016, 4:42 pm

      Cold Truth, I could not agree more, which is why I joined Money Coaches Canada as a fee-for-service money coach. It is not as easy as being an investment or insurance salesperson, but it allows me to work purely in the best interests of my clients, which allows me to sleep very well at night.
      Stev

  • Pellrider November 7, 2016, 12:23 pm

    This one picked my interest: “used it as collateral for a loan from the bank.” That is exactly my friend at the WFG was talking about. If I invest in the insurance I can take a loan against it, and might be paying a 1% interest on the loan and can avoid paying tax on the amount withdrawn on my retirement.
    This can work for people who have high income and lot of assets. I don’t think an average family earning about $100,000 per year need this kind of insurance to avoid taxes in in retirement. I wish all parents read this post before jumping into buying whole life insurance for their kids.

    • Brandy November 24, 2016, 10:50 am

      I thought it was more about getting a loan for yourself and not just about the saving money in retirement? For example, kid grows up and wants to buy a car. Kid takes loan from his/her life insurance policy. Kid pays back life insurance policy plus interest. Kid’s policy grows even more.

  • joy November 7, 2016, 12:55 pm

    The best investment for Children is the whole life insurance,not stocks,real estate or mutual funds

  • Greg November 7, 2016, 2:14 pm

    good article. The financial planner is not really a planner, they are a financial products salesperson. I wish they would just call themselves that.

    Also, the math doesn’t add up. Investing $1500/mo for 20 years only totals $30,000, much of which would be going to the insurance premium. For the minority portion that went to the investment portion to grow to $1 million by the children’s retirement, implies pretty high returns. Do the math. This is a red flag.

    Max RESP first, and find a new “planner”.

    Overall, remember that insurance is for Assets, not liabilities. Children are liabilities. Do not insure liabilities it makes no sense.

  • Sim November 7, 2016, 6:53 pm

    We have a Whole Life policy and have maxed out our RESPs for both kids. I’m very happy with both. Be cautious when taking counsel from anyone who claims to be impartial yet likes to ridicule one product or the other.

    Also, there are term products in the marketplace that offer more compensation than Whole Life policies.

    • LifeInsuranceCanada.com November 29, 2016, 12:24 pm

      >>> term products in the marketplace that offer more compensation than Whole Life policies.

      Frugal trader attended a conference where I debunked a lot of insurance myths. One of those was showing an example where I was paid more for a term insurance sale than a whole life insurance sale.

      Most insurance advisors frankly don’t have a clue how to calculate what they’re actually paid. There are incorrect sales practices going on, but the cause of those are very unlikely to be because ‘paid more’.

  • Big Cajun Man (AW) November 8, 2016, 12:19 pm

    I was worried there for a while, that you were espousing Whole Life Insurance for Kids. Buy RESPs, put money in Trust, use your TFSA, pay off your debts and teach your kids about how money works, those are the best things to do for your kids financially.

  • Kent Tilley November 9, 2016, 2:01 pm

    This is a great article, thank you for explaining that in simple terms for people to understand. Whole life insurance policies do have a place in the market, but as you said are only meant for a very small percentage of the population. Unfortunately the insurance industry is way behind the 8-ball as far as being regulated is concerned, so most of the time when people buy insurance they are getting their advice from a salesperson and not a certified financial planner who is trying to use insurance to protect their financial well-being. With that said, a lot of CFPs would recommend this as well, because the commission is so high.

  • Forebiz November 9, 2016, 6:46 pm

    While I agree completely with the article my wife and I purchased a whole life policy 17 years ago that we will need to continue paying into for another 3 years to complete. It pays $300K each upon death and cost us $1035 and $756 a year (not month) each. We met with our life insurance guy a few years ago to get more and possibly purchase for our children and nothing like this is available anymore with rates similar to what the article stated.

    It has a reduced cash value until age 100 where it is equal to $300K but at 5% interest on a similar investment payed for first 20 years I would have to live to 85 (90 for wife) before we would make over $300K at that rate.

    I don’t know how or why we received such a good price 17 years ago but we decided to buy extra term instead for ourselves and not bother with anything other then RESPs for kids. Agent didn’t seem pleased with our decision.

  • Ed Rempel November 12, 2016, 10:25 am

    FT,

    Whole life insurance on young kids is crazy! None of the parents I know are financially dependent on their 2-year old kids. :)

    This is an insurance salesperson, not a financial planner. Arlene did not receive a financial plan – just a sales pitch.

    Part of the solution here is restricting use of the term “financial planner”. It needs to be restricted to only CFP Professionals.

    Insurance and investment salespeople routinely call themselves financial planners. Web site call themselves advisors. My doctor calls himself a financial planner – as do a few of my drinking buddies.

    The Financial Planners Standards Council (organization of Certified Financial Planners) has joined with the other planning organizations to create the Financial Planning Coalition which has proposed to the Ontario government legislation to restrict use of “financial planner” to CFP Professionals.

    Let’s hope this is approved. It would go a long way to protecting people like Arlene.

    If this “financial planner” had said he was an “insurance salesperson” (which is accurate), she could have more easily seen through this “advice”.

    Ed

    • LifeInsuranceCanada.com November 29, 2016, 12:27 pm

      And I’ll make sure to raise the requirement that those organizations prove ahead of time that in practice, a CFP designation actually avoids all the problems they’re claiming.

      In practice from what I’ve seen, the people that are CFP’s overall are no better or worse, or more likely or less likely to do any of this stuff, than the general population. Really Ed, you think CFP’s aren’t out there flogging whole life on kids? Because they absolutely are.

      CFP isn’t a solution to anything.

  • Susan November 13, 2016, 12:38 pm

    Ok, many years ago I was also of the same mindset.

    “As I mentioned, insurance is to mitigate against financial risk. The only real financial risk when it comes to her children passing away is the cost of the funeral when they are young. If this cost is a real concern, they can purchase a cheap term insurance to cover potential funeral costs (some providers offer $20k death benefit for around $30/year).”

    Then I watched my friend go through her son’s death. And I figured out that the financial risk was MY income. There was no way I would be able to go to work for a period of time if one of my children died. So the insurance is not protecting their income but mine. Again, the math doesn’t make sense in theory. But if you think about one of your children passing away, could you work? I couldn’t, at least for a while. Insuring my kids gives me that option. In a perfect world I would be financially able to deal with this with my own resources but that unfortunately is not my current situation.

    Now as to the whole life question, I may have been mislead on that but I was told that it was not possible to get term life insurance on children so yes, I do have whole life policies on the kids for about $50K each (which tax free would cover us for about a year if we had to use it). For that we pay abot $130 per year per kid.

    Sometimes personal finance has to be more personal than just math.

    Susan

  • Sim November 13, 2016, 8:24 pm

    You are completely correct Susan. Everyone has their own unique needs. A Whole Life policy makes complete sense in your situation. Unfortunately many experts(including some on this thread) believe that their way is the only right way…and anyone who disagrees with them is in the wrong.

  • Ed Rempel November 13, 2016, 10:56 pm

    Susan,

    You make a very valid point.

    I would suggest, though, that a term policy is what you need. You can get it as a rider on your own life insurance policy. That should reduce your $260/year to about $20-30.

    If you do buy a whole life, once your child is an adult, just cash it in. Don’t expect them to take over such an expensive policy.

    I have had clients in their 20s that took over whole life policies their parents had made 25 years of payments on. The premium for the $30,000 whole life was about the same as a $500,000 term for them. It made zero sense to have it and their cash flow was tight, but they felt obligated to keep the expensive whole life policy. Don’t stick your kids with an expensive policy.

    Ed

    • Stephen Weyman November 14, 2016, 2:06 pm

      CONTRARIAN OPINION INCOMING:

      I totally get the hate-on people usually have for whole life insurance. Most of the time it doesn’t make sense, I agree.

      Personal story:

      My father took out a small 20-pay whole life insurance policy out on my sister and I. He did 20-pay so we wouldn’t be burdened with the payments when we were adults and MOST importantly because the policy came with 3 opportunities in the future for each kid while in their 20s and 30s to purchase an additional $100,000 in term or other insurance at the standard rates without any sort of medical exam.

      Long story short – I am very lucky my father did this for me because I got Type 1 Diabetes when I was 24 and would never have been able to qualify for reasonable insurance rates that covered me for everything (Diabetes can affect pretty much every part of your body negatively in the long term). The only insurance I would have been able to qualify for is minimal group life insurance if I worked for the right employer that offered it.

      Working for myself like I am now would have been so hard without being able to qualify for that $300,000 in term insurance. I also got lucky with my last employer offering a guaranteed insurability benefit if you opted to buy personal health insurance after leaving the company – otherwise I’d be paying through the nose for that as well or getting by uninsured with my high medical expenses.

      I purchased a small $10,000 whole life policy on each of my kids for this very reason – guaranteed future insurability.

  • Garry November 13, 2016, 11:48 pm

    Doesn’t insurance for a child protect the risk of that child becoming, unfortunately, uninsurable in the future?

  • Michael November 14, 2016, 7:01 pm

    Garry, I think you are correct. The purpose of life insurance on your kids is not at all about mitigating financial risk. It is about mitigating the risk of them becoming uninsurable and secondarily as tax-deferral / estate transfer / investment mechanism. I’m not advocating for whole life, but there are situations where it may make sense but generally not for the purposes of the normal population. I’m skeptical as to whether this explained to Arlene and whether it is a good product fit for her.

    Regarding “check the numbers”, the likelihood of claiming on a child policy is very low, so the “cost of insurance” is a very small portion of the premium being paid. Even from birth, life expectancy is probably now something like 85 or 90, so its not hard to fathom the premiums growing up to the millions by the time you reach life expectancy. Run the numbers – even if the first 5 years of premium are chewed up by expenses and to fund the cost of insurance, you get up to the millions without having to pick wild investment return assumptions. The figures are eye-popping but that’s because the effect of 90 years of inflation is somewhat lost on us as well. I’m sure a $50k death benefit would have been eye popping when my grandparents were born.

  • FrugalTrader FrugalTrader November 15, 2016, 2:32 pm

    Good points here guys, thanks for the balanced discussion. Can anyone comment on getting term insurance for children? Is it as simple as adding a rider to existing life insurance?

    • Kent Tilley November 15, 2016, 2:59 pm

      I can comment and I will go back and apologize as I don’t want to suggest that insurance on children is a terrible thing as I know I would not be able to function if something happened to my son.
      I looked into what I can offer as I only work with one carrier now, and I would unfortunately not be able to offer more than $10,000 as a rider on the life of a child. Yes, it is as easy as just adding it at the time of application. Adding it later might involve a small amount of underwriting, because they may assume you know something they don’t. It’s about $2.50/month/$10,000.
      Unfortunately, that is all I would be able to offer as a rider, so for a parent who would want more, they would need to purchase a permanent policy on their child if I was their agent.
      However, I am quite certain that their are other insurance carriers that allow you to have increased life riders on your children if you don’t want to buy a permanent policy.

      My problem is not with the insurance or the policy itself, I just know that a lot of parents are sold the product for the savings aspect. Yes it looks great, but there are effective ways to save for your kids without resorting to permanent insurance. That was my point.

  • Brad November 17, 2016, 4:06 am

    I’m curious to why you can’t take out the cash or investment portion of the policy? Also what about participating policies? What are your thoughts on them?

  • James Bilcox November 18, 2016, 12:00 pm

    One of the big financial and peace of mind reasons I was able and confident to pivot to self employment in my 30’s is because an life agent (God bless his soul) approached my parents shortly after my birth and suggested they acquire some child whole life on me and my brother. My parents funded them over 25 years until they felt comfortable changing ownership to us. I was told to never surrender them and they would be an effective tool in my future financial plan. Indeed they have been. There is close to $50k of secure and accessible leverage there as i grow my business. Projections indicate they may be worth as much $250k by my age 65. Certainly help and cheap capital. My brother also became a successful freight broker in his own business in part because of those child whole life policies…so before we go beat up on the tool, lets ask ppl who have successfully used it how it’s going. If i could ever find that life agent, i’d buy him a steak dinner and give him a huge hug. He likely has no idea of the legacy he helped initiate. All the best!

  • LifeInsuranceCanada.com November 29, 2016, 12:19 pm

    You said:
    “The only real financial risk when it comes to her children passing away is the cost of the funeral when they are young.”

    Absolutely, 100% false. That is not the only real financial risk. It’s not even the biggest one. You’re treating the death of a child like the death of an adult. It is not the same.

    The biggest financial risk is loss of parents’ income. You lose a spouse, people are back to work in a few weeks. You lose a child, people are off work for many months, maybe years and they might be part time for an extended period. This isn’t hypothetical – it’s what actually happens, in real life. Losing a child is not the same as losing grandma, or even a spouse. Insuring a child for 6 months income for both parents is entirely reasonable. Insuring a child for more, still reasonable. Source: I’ve seen this numerous times and I’ve *never* seen a parent return to work in a short period of time.

    Based on that alone, many children are woefully underinsured.

    Secondly, a bit of money set aside to pay for a funeral at a very difficult time isn’t the worst thing in the world. You can argue emergency fund, but in practice, does an emergency fund actually exist? Further, there’s some level of value > 0 to having a cheque delivered so you don’t have to think about financial affairs at the same time. Source: speaking to people who’ve had life interrupting events like this where there’s technically no insurable loss or it can be covered by an emergency fund. Those folks will tell you that in retrospect, the insurance premiums would’ve been worth the ‘peace of mind’, as vague as that sounds. The practical applications differ from the hard math. What’s that worth? Something. Source: People will pay for liquidity, see your own personal investments for an example.

    Those are reasons for term insurance on children. The reason for permanent is to lock in future insurability. Again, the value of this is not necessarily 0. If you have factor V Lieden, diabetes (I can’t even write that without hearing Wilford Brimley), Polycystic kidney disease, or many others running in your family, you may be very willing to pay $ in order to guarantee that your kids have insurance in the future even if they develop one of those conditions. If you can see that, you can see that the value of future insurability is >0. There’s lots of other personal reasons, which means guaranteeing future insurability isn’t a 0 – it’s something to be discussed and a value placed on it. And a non-zero value that’s >= premiums is a personal financial decision. The answer is not a simple ‘it’s worth nothing, because I place no value on it’.

  • LisainSK November 30, 2016, 4:41 pm

    We were in this exact same scenario earlier this month and in the end we chose Term Life Insurance for our son. We purchased the insurance for the scenario of should our son pass away, both my husband and I would be incredibly devastated and would rely on the insurance money as a way to fund lost income while we grieved/took leave of absence from work.

  • LisainSK November 30, 2016, 4:44 pm

    Also, we do not know the full genetic history of our son and we want to make sure that he has the opportunity to have some kind of insurance that he could roll over into an adult life insurance policy should he acquire a disease in his childhood

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