Should I buy Whole Life Insurance for my 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!
What is Whole Life Insurance?
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:
- 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.
- 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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There seems to be a misconception about WL, contrary to majority , there is a certain WL policy when structured properly, will supercharge the value of the policy. I think the return is safer than mutual fund or any investment, sometimes can be higher. Plus the fund value can be borrowed against it while fund value is growing untouch. Bank and corporations use this kind of corporate owned insurance. Can’t blame why WL doesn’t have the respect of most people. With this kind of WL, the commission is reduced from 40-60%. Only a few insurance company in canada is applying this kind of WL. James Bilcox might have their WL structured properly.
Guy,
With a whole life policy, all the investments are interest-bearing. In the last 57 years, several decades had very high interest rates.
If you bought that same policy today, you would be lucky to get a death benefit of $5,000 after 57 years.
Also, if you “buy term and invest the difference”, you don’t have to die to get the large return after tax! :)
Ed
To quote Ralf Nader ” The life insurance industry is a smug sacred cow feeding the public a steady line of sacred bull” Whole life is the worst financial insurance product out there.
57 years ago a client of mine bought a whole life policy on his new born son. The $7,000 policy had monthly premium of $5.00 a month.
Over the last 57 years the cost of carrying this insurance amounts to $3,420
Because he chose the paid up additions option the dividends kept buying him more insurance each year tax free. Today, the death benefit Is a little north of $59,000. TAX FREE. Tell that to Ralph Nader
Lisain,
Two points:
1. You also get guaranteed insurability with term insurance, which is far cheaper than whole life. Just get the guaranteed renewable and guaranteed convertible options, which usually cost almost nothing.
2. The big problem with life insurance for kids is inflation. You can’t get a meaningful policy now.
You are trying to get something your son could use as his personal policy when he is an adult. Most couples in their 20s need around $500,000 of life insurance to replace their income to support their spouse and family. In 25 years after inflation, a meaningful policy would be at least $1 million.
A policy you get today may be $50 or so, which would be tiny in 25 or 50 years. It probably wouldn’t even pay for a funeral, never mind support your son’s family.
As an example, a client aged 50 told me his 75-year-old parents had bought a whole life insurance policy when they were first married to pay for a funeral at that time. That was just before this client was born. He asked me what his parents should do with the policy now.
I asked what the death benefit on the policy was. He said $1,000! I told him to tell them to just cash it in. The amount is so small it is just an annoyance.
Ed
Thanks Ed! Yes the term insurance we have for our son is a guaranteed renewable once he’s an adult. So we are covered in that aspect…but yes I wish we could take out more insurance for him but we currently pay $10,000 a year for a variety of life, critical illness and disability insurance (over and above employer coverage) for all members of our family. So without getting more “insurance poor” we at least can insure ourselves and protect what we’ve accumulated over the years.
HI Lisain,
$10,000/year for insurances?? That sounds awfully high!
I have prepared comprehensive financial plans for nearly 1,000 families and have never had that much insurance. Even when I have the classic case that should produce the highest insurance – a doctor making a high 6-figure income with a stay-at-home wife – total insurance is usually only about half of what you are paying.
I have not yet come across anyone that needed that much insurance (although it is possible), but I have come across many people being oversold insurance.
I am a big believer in “Buy term & invest the difference”.
Are you sure you need all that insurance, Lisain?
Ed
Hi Ed,
Our total insurance bill per year is $9,957.57 per year. I will break it down:
Disability Insurance Policies for myself and husband over and above what work DI benefits is (which is minimal) = $6,037.51. I hate the DI insurance bill but we are both late 30s with high expenses right now (mortgage, young son) and as the mortgage bill goes down, then we will drop off the DI supplemental insurance. But if something were to happen now, it would be a killer for us. My husband’s income is fortunately quite high so we need to protect the difference of what his base salary is compared to his actual salary. Mine too.
Critical Illness Insurance for husband, myself and son = $1,698.92. This is strictly a personal preference type insurance. My friend died of breast cancer at age 37 (my age) three years ago and it was a killer for them. They spent over $300,000 in treatments trying to save her life. The CI on son is meant to spend on treatments or cover off our net income to have one/both of us stay home to care for him. So CI insurance is purely “lets me sleep at night” insurance.
Life Insurance for husband, myself & son = $2,221.14. I am insured to $1,000,000 and husband is insured to $2,000,000. Son is insured to $150,000 and is whole life since we do not know his full genetic history and can increase insurance after age 18 to higher amounts.
Insurance is extremely personal decisions based on family history/genetics, present and future income values and peace of mind. I am sure we are our Financial Planner’s dream clients. But we also invest over and above our pensions as well and balance it out with insurances to protect our current and future net worth. If it helps me sleep at night – then its money well spent. And yes, our Financial Planner is a CFP amongst several other professional designations and not just another “insurance salesperson”. We trust her fully and have been with her for 10 years.
At this point, all of our insurance products are meant to preserve our current net worth and insurance products will drop off in time.
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
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.
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’.
This is a good point. A question for insurance people out there, would a child dying causing “stress leave” be eligible for disability insurance benefits?
Yes, if you have a professional policy, or one that does not limit mental health claims, then the disability would depend on whether you are able to do the important duties of your occupation at time of claim. If you have anxiety, depression, PTS, even fibromyalgia (conditions which cannot be confirmed by a diagnostic test), then these are legitimate claims. It is ultimately up to the APS (attending physician statement) that will determine whether the insured can perform their duties or not.
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!
This is the story I hear repeatedly. Accessible leverage.
FT any comment on this strategy?
Hi Bobby, I haven’t seen much on accessible leverage but will take a look. Can you talk a little more about the strategy?
I wrote that comment hastily/copied the wording from James. What I meant was accessible funds that can be leveraged throughout the child’s life. I heard someone else make the same comment: “If I ever met the broker who sold my parents that policy I’d buy him dinner because I used that policy to help fund me education/company/home, etc…”
I was curious and found a company that is literally built on this strategy (https://www.insuranceforchildren.ca/child-plan/). They have a simple illustration down the page that shows you how much the child could borrow from the policy at certain points in time.
I guess the idea is spend $100/mo on a Pay-25 policy for your kids, and they can borrow against the CSV for certain milestone expenses, while also letting the death benefit accrue.
If someone has their RRSPs, TFSAs, RESPs maxed out, and a healthy non-reg balance, buying a whole life policy for your young kids might not be a bad idea. What do you think?
Dividend paying Whole life can be structured to be leveraged. This is of different whole life insurance that most agent or ‘financial advisors’ don’t know of. Basically, you finance everything you buy. From car, real estate, business expenses, vacation, kids education etc. Doing this, you save a lot of fees and taxes. For kids education for example, if you put in RESP, when the child goes to college, you use the RESP and ,if tuition is not enough , parents will likely add more money towards tuition. After college, that money is gone from parents pocket, and to taxes and fees. While in Whole life, if structured properly, you borrow from the cash value, use in education, pay back the cash value, then re-use the cash value again. the money you put to education keeps going back to your whole life cash value. so at the end , the kid finished college at the same time, you still have the money from whole life. Very few agents know how to structure this kind of policy, most even discourage clients, even if you search internet, it is full of ‘financial advisors’ against whole life. I am not saying that one should avoid investing in stock market(RRSP, non-reg, RESP etc). but dividend whole life is a compliment if you want to finance everything using cash value in whole life. I am a licensed insurance agent practicing this concept. This kind of whole life has a cash value even on the first month, then dividend paid every year. I have helped a lot of people/businesses using this approach. Thing is , the need for finance is much greater than the need for protection. Properly structured whole life will help while living than alive.
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?
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?
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.