The dangers of buying life insurance for your child
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Updated on March 7, 2018: There are a lot of costs that go into raising your child. From box after box of diapers all the way through college, it can cost you nearly $250,000 to take your bundle of joy from bassinet to their college graduation. That’s probably why so many people think buying a life insurance policy for your child, like the kind you see in Gerber commercials, is a good investment. They think it’s the best way to set money aside for college, but here’s what companies like Gerber don’t tell you: Life insurance is a bad way to invest overall, and your child doesn't even need it.
Child life insurance products are a type of whole life insurance specifically designed to cover children. Whole life insurance products, whether they're designed for children or adults, are a type of life insurance that features a savings component. This savings component, also called the cash value, is designed to grow over time. In the case of the aforementioned Gerber Life College Plan, you're guaranteed a payout of between $10,000 and $150,000 when the policy reaches maturity.
Check out this video which explains what whole life insurance is and why term life insurance is the preferred life insurance for adults:
The cause of that huge range ties back directly to how whole life insurance works.
There are a ton of variations of whole life insurance, so the following explanation is a simplified version of one popular whole life policy construction. The cash value of your whole life insurance policy is growing thanks to dividends. Those dividends are based on the life insurance company's profits. While the insurer typically presents dividends as increasing over time, it's more likely that dividends will decrease down to the policy's guaranteed minimum. The guaranteed minimum is the smallest dividend that the life insurer can pay you, and it is typically much smaller than the dividend you start with.
In a child life insurance policy, the only guaranteed growth is at the small end of the range — in the case of the above Gerber Life plan, $10,000. Anything above that minimum is not a sure thing, and depending on the policy, maybe even unlikely.
Whole life insurance policies also feature high fees and may be prohibitively expensive. It's likely that you'll end up putting more money into the policy than you'll ever get out. There's a good reason that Dave Ramsey calls whole life insurance — and by extension, child life insurance — "one of the worst financial products available." You can learn more about term life insurance vs. whole life insurance here.
One way that Gerber Life tries to sell their College Plan policy is by presenting it as the easiest way to save for college. But there are a ton of easier and better ways to save for college, and chief among them is a 529 college savings plan.
A 529 college savings plan is simple in concept. It's just a savings or investment plan with tax-advantages specific to education costs. You can kind of think of it as an IRA for college savings.
The tax breaks are the 529 college saving plans' biggest advantage over child life insurance policies. As long as you use the money from the 529 plan on qualified educational expenses, Uncle Sam will not take a dime. This doesn't just mean college — the 529 plan could also be used to pay for a private high school, for example.
There are also a ton of benefits when it comes to financial aid. One of the biggest is that you don't need to declare earnings from the 529 plan as income. Example: if you take $40,000 out of the 529 plan to pay for a semester of college, you don't have to declare that as income on your next FAFSA form. Not so for child life insurance — if you get a big payout of $150,000 from a child life insurance policy, all of that counts as income for the next year, putting grants, scholarship, and financial aid at risk.Like any investment plan, there are risks and downsides associated with 529 plans. However, when compared to other types of savings schemes, the 529 college savings plan shines. For more information on both the pros and cons, check out our comprehensive guide to 529 college savings plans.
Your child doesn't really need life insurance. Life insurance is intended to pay off debts and act as an income replacement in the event that you prematurely die. Most children don't have large debts, and most families aren't relying on their child's income to pay the electricity bill. It's far more likely that you need life insurance. You can go here to learn how to determine how much life insurance you need here.
However, some people do like knowing that, in the terrible scenario where a child dies, there is a life insurance policy to pay for a funeral, allow parents to take time off work to grieve, and cover other associated costs.The best way to insure your child is to purchase a child rider on your own term life insurance policy. Most term life insurance policies have the option to add on a child rider. For a small fee, you'll be able to expand your own life insurance policy so that it provides a small death benefit in the event that one of your children passes away.
Child riders are simple and relatively cheap, especially when compared to a child life insurance policy. For more details on how a child rider works, contact your life insurance company or read our guide to child riders.
Rules are meant to broken, which means advice like "never buy a child life insurance policy" obviously has a catch.
If your child has a higher than average chance of developing a medical condition that would be make buying life insurance as an adult either more expensive or impossible, you should buy a child life insurance policy for them while they're young. Most child life insurance policies allow children to keep the policy once they mature, even if they develop health conditions as a child or in adulthood that would otherwise be uninsurable.
However, this doesn't mean you should buy a child life insurance policy "just in case" your child develops an uninsurable medical condition. Instead, look at your family history. If your family has a history of children developing debilitating medical conditions that are genetic in origin, you should buy child life insurance. Otherwise, you're probably wasting your money.
Image: Ben White
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