Take a second and think of your favorite infomercial voice, then read this:
Has this ever happened to you? Your parents hand you a life insurance policy that they purchased for you when you were a kid and tell you to start paying for it. Uh – what!?
This past spring, a friend of mine started paying for a whole life insurance policy that his parents bought for him when he was a baby. As someone who writes about life insurance for a living, I was literally the only person interested in his story (sorry, Thomas). But it did get me wondering – what do you do with a life insurance policy that your parents bought for you when you were a child?
Unsurprisingly, there’s not a lot of information about this on the internet. (Key exception: this Reddit thread from two years ago.) So I sat down with one of our life insurance experts, Brian Grimes, CFP, a senior client services manager here at PolicyGenius, to talk about this scenario. About two seconds into the conversation, it became very clear why there isn’t a lot of advice about this on the internet: there are a lot of options, and what you do with the policy needs to be tailored to your personal financial plan.
Not every option I detail below will be available with your life insurance policy. There are a lot of variations of life insurance policies out there that are specifically sold to cover children. Most of them are a variation of whole life insurance or another type of permanent life insurance, and if your parents are trying to pass it over to you now, that’s probably the type of insurance you have. Permanent life insurance has a savings or investment component called a "cash value," which, true to its name, accrues value over time.
Why do parents buy child life insurance for their kids? The two main selling points are that it locks in insurability for when you’re an adult and it accrues a cash value. While we don’t suggest that parents buy child life insurance – the majority of children don’t need their insurability locked in and there are better ways to invest your money, especially for college – that’s beyond the point in this situation. You already have the insurance policy, now you have to figure out what to do with it.
1. Take ownership
The first thing to do is take ownership of the policy. If your parents want you to start paying for it, you should put in an ownership transfer request through the carrier and add yourself as the payer on the policy. Becoming the owner takes it out of your parents’ hands and officially makes you responsible for it. (If your parents add you as payer without putting in an ownership transfer request, you won’t have full control over the policy.) While you’re doing this, you should also check on the beneficiary of the policy – most likely it’s one or both of your parents, but you may want to change that to your partner or spouse.
2. Get unbiased advice
Next, you’re going to want to contact the life insurance company and ask for an "in force illustration." This illustration will lay out exactly what’s happening with your cash value and what your options are for the policy. You’re going to want to take this illustration to a fee-only financial advisor who can interpret the illustration and, along with other information about your finances, give you advice on the best option moving forward. We suggest a fee-only advisor as opposed to a commissions-based advisor in order to ensure that they’re unbiased in their advice. You can use a website like Guidevine (read our review here) to help find a financial advisor in your area.
3. Consider your options
Depending on the policy and your needs, you could have a number of different options:
You may have the option to use the cash value to fund the policy, leaving you with no premiums to pay and a small cash value accruing dividends over the next few decades.
You may also have the option to design it so that it kicks you the dividends directly, which won’t grow the cash value but will grow your bank account.
You could also cash out the cash value and invest it in something more aggressive; whole life insurance is an inherently conservative play, and because you have a long period of time before you need money for retirement, it may make more sense to take the income tax hit now and better utilize that money in a more aggressive investment portfolio.
If that sounds like a lot of confusion options that depend on a lot on your individual policy and financial situation, you’d be right!
We just have one more option we want to mention: a 1035 exchange. A 1035 exchange is when you use your cash value from an old whole life policy to buy a new permanent life policy. Permanent life insurance products include universal life insurance, variable life insurance, and whole life insurance. You could also move the money into an annuity, which would allow to avoid the tax hit on the cash value accumulation.
We generally don’t suggest that people buy permanent life insurance. It’s more expensive than term life insurance and it’s not a great investment vehicle. However, it may make sense in this situation, primarily because you can save money by using that initial cash value. If you’re interested in this option, make sure you talk to your financial advisor so you can compare it to your other investments and insurance needs.
For more on the differences between whole life insurance, the most popular kind of permanent policy, and term life insurance and why we suggest that the vast majority of Americans choose term, check out Brian Grimes explaining it in the video below:
Before you make any decisions, however, grab that illustration and take it over to a fee-only financial advisor. Get independent, objective advice on your next move. At the end of the day, this life insurance policy is a giant cash gift from your parents, and you want to make sure you utilize it in the best way possible.