Depending on what you read, buying life insurance for children is a great act of love or a terrible idea.
Insurance companies tout the coverage as a way to save money for kids and “protect their insurability” — meaning their ability to buy more life insurance later, no matter their health.
But many financial planners caution against spending money on child life policies, saying there are better ways to protect children financially.
“I struggle with thinking of reasons why it would make sense,” says Joseph Alfonso, a financial advisor in the San Francisco and Portland, Oregon, areas.
How life insurance for kids works
Most child life insurance policies are whole life, a type of permanent life insurance. Whole life policies include a savings account called cash value, which grows slowly over time.
The Gerber Grow-Up Plan from the Gerber Life Insurance Co. is among the most well-known of these policies. But you can buy a whole life policy covering a child from just about any of the biggest life insurance companies. A parent or grandparent can transfer ownership of the policy once the child reaches adulthood.
Most child life insurance policies are whole life, a type of permanent life insurance.
The other major type of life insurance is term life insurance, which lasts for a set number of years. You can’t buy a standalone term life policy on a child, but you can pay extra to add a small amount of coverage for a child to your term life insurance policy. The coverage for the child will expire at the end of the term or when the child reaches adulthood. (Learn more about the differences between term life and whole life.)
About 20% of parents and grandparents say they have purchased life insurance for kids, according to a survey of 2,000 adults by industry groups Life Happens and LIMRA.
Reasons to buy — or not
The sales pitches for life insurance for children can be persuasive, but it’s never a good idea to buy anything based on the marketing alone. Here’s a look at the most common pitches and the counterarguments.
It provides a savings vehicle
For: The savings component of a permanent life insurance policy, called cash value, grows slowly over many years. The policy owner can borrow against the cash value or surrender the policy for the money, minus a possible surrender fee. The cash value growth is tax-deferred, meaning it isn’t taxed as income until you withdraw money or surrender the policy. A withdrawal is taxed only if it exceeds the premiums paid for the policy.
The cash could be used for anything, including college expenses or the down payment on a home. A whole life insurance policy guarantees a certain percentage return on the cash value and compares well with other conservative savings vehicles like CDs, says Marvin Feldman, CEO of Life Happens, a consumer education group funded by the life insurance industry. “It isn’t designed to be a primary savings and investment tool. It’s one of the tools for parents and grandparents to consider.”
Against: “The fees associated with life insurance policies usually eat away at the rate of return,” says Carrie Houchins-Witt, a financial advisor in Coralville, Iowa. She encourages her clients to think about how much life insurance fees would grow over time if invested elsewhere, then compare that to the cash value of a policy over the same term. “There are a multitude of opportunities to make a better return than through investing in life insurance,” she says.
Tip: Learn more about 529 plans and other college savings strategies.
It locks in a child’s ability to qualify for more life insurance later
For: A child who develops a medical problem early in life might have trouble qualifying for coverage later. By purchasing coverage now, you guarantee the child has some coverage and can buy more as an adult, regardless of health. This is a big reason people purchase life insurance on their children, Feldman says. He says he bought life insurance policies for his children and grandchildren.
Against: It’s “an expensive proposition for a remote risk,” says Keith Amburgey, CEO of Rutherford Asset Planning in Tampa, Florida. “The vast majority of 20- and 30-somethings have no problem getting insurance.” In addition, Alfonso says, the amount that can be purchased later because of the “guaranteed insurability” is limited to a multiple of the original policy amount. In many cases, that total is too small to provide adequate coverage later in life anyway.
Tip: Make sure you have enough life insurance. Inexpensive term life is sufficient for most families. See A New Parent’s Guide to Life Insurance.
It provides money for funeral expenses and other costs
For: In the event of a child’s death, a life insurance payout could pay for funeral expenses, family counseling and medical bills and provide money for the family to get by if the parents need to take leave from work.
Against: Statistically, the odds of a child dying are very slim. A smarter financial move than buying life insurance is to stash money into an emergency fund, which could be tapped for any type of crisis, Amburgey says.
Tip: Learn more about how to build an emergency fund.
Before you buy life insurance for children
Look at your entire financial picture to make sure you’re saving enough and covering bigger risks. Get advice from a fee-only financial advisor — that’s one who doesn’t make commissions on life insurance or other products — before buying coverage on a child. The main purpose of life insurance is to replace income or cover debts in the event of someone’s death.
Financial planners say both parents generally should have life insurance while their kids are growing up. NerdWallet’s life insurance comparison tool can help you find the right coverage amount and compare prices.
This article was written by NerdWallet and was originally published by Forbes.