Should I take out a whole life insurance policy on my child?
The insurance salesman who recently helped my wife and I with our term policies mentioned that one of the advantages to a whole life policy is that you can take one out on your child 15 days after they are born for $150,000, and the monthly payment would be rather small. The advantage though is that you can put your child's savings into the cash balance portion and when your child comes of age you can sign the policy over to them and the built up cash value could assist with student loans, a wedding, a house, etc. This would provide guaranteed safer returns than the market, but also better interest than a regular savings account. Is this a good strategy, or would I be better off simply setting up a mutual fund instead? I am not a fan of 529 plans.
I would recommend an investment fund and this is why. When you use a life insurance as an investment vehicle your premium payment will be divided into three parts. First, a portion of the premium will go towards the cost of insurance. For a child this is going to be small, it is to cover the risk of the insurance company paying out a death benefit. The second portion will go toward the investment base in the policy. For a whole life policy this is usually based on US treasury rates and will be close to the interest amount provided with a bank savings account. The last part is not discussed, it is the cost that goes to cover the insurance company's operation and sales force.... (this is how they pay the sales person).
The insurance company usually pays the insurance representative half of the premium received over the first year and then a smaller percentage each subsequent year the policy is maintained. In order to protect the amount paid to the sales person, the insurance company will require you to keep your money in the policy for a period of time. This is to ensure if the policy lapses (is stopped) their payout is covered. This is where the idea of “surrender charges” comes from. If you look at their illustration, this is also why the cash value is so small in the first couple of years.
What they don't tell you is you can't take all of your money out of the policy without surrendering the policy. Let's assume that the policy grows to $25,000 in value 20 years from now, you can absolutely access some of the cash, but not all of it, a portion of the cash value has to remain in order to fund the policy going forward. Therefore, if you surrender the policy to get access to all of the dollars, you are going to forgo the tax advantages promised.
If you surrender your cash value life insurance policy, any gain on the policy will be subject to federal (and possibly state) income tax. ... Your basis is the total premiums that you paid in cash, minus any policy dividends and tax-free withdrawals that you made.
Something a life insurance policy does really well is it requires policy holders to make premium payments (Forced Savings). If you are someone that can stick to systematic savings, then I would forgo purchasing a policy. If you need insurance, buy insurance, if you want to invest, then invest. I wouldn't do both in the same product.
If you are able to accept market risk, then I would recommend investing in an indexed ETF fund like SPY. The SPDR® S&P 500® ETF Trust seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500® Index (the “Index”). There are different ETFs and they operate a great deal like Mutual Funds but with lower expenses. Just do a quick search and find an ETF that meets your investment objectives. If you want something less volatile, then I would invest directly into a CD or Savings account. Rates are rising and you can find savings products available now that are paying 2 to 2.5% interest.
I have had a policy on my life sense age 3 months, thanks for my parents. I did the same for my daughter at 15 days old, and in fact we do it for the bulk of our clients.
What you are doing is creating a Gift for your child. You can use the cash values in the life insurance contract for anything. Life and annuity contracts also are not counted towards FASA, while a 529 plan is.
It would be wise to set the plan up with the max funding you can achieve which is IRS code 7702a MEC (modified endowment funding) This is yet another gift in the IRS tax code.
We are happy to explain more, but we should have a conversion.
Best to you!
Dear Should I take out a Whole Life Insurance Policy on my Child?
UNDERSTAND THE INVESTMENT STRATEGY THAT WORKS FOR YOU
The strategy that will work for you and your family is the one that makes the most sense for you.
It is important for you to review the basics of owning a Mutual Fund long term, the type of fund and the implications of owning a Mutual Fund on behalf of your child versus the aquisition of Whole Life Insurance.
What ever your choice, minor ownership interest in funds deposited in trust whether into a Mutual Fund or Whole Life Policy are owned by you (the adult) until such time as your child reaches the age of majority.
MUTUAL FUND INVESTING
Investing in long term ownership of a Mutual Fund Family of your choosing may provide a return of stock performance within that fund over time depending on the Industry Selected, the performance over time and the management team. Management fees are charged for ownership of a fund, if the stocks perform well as a Fund made up of S&P 500 select stocks there can be 10% annualized return on investment over time.
WHOLE LIFE POLICY
Conversely, investing in a Whole Life Policy to benefit your child (as early as 15 days after birth), is a gift that lasts greater than one life time. With an initial policy for as little as $25,000 as long as you continue to make timely premium payments, the Whole Life Policy will provide a death benefit protection as well as create a living legacy by the accumulation of cash value year after year often with a choice of funds and ETFs to provide a head start for your child's financial future. Cash accumulation over time can be borrowed against by your child at a later date to put a down payment on a home, pay for college, start a business, afford retirement. Riders can be added to increase the value of the policy. A loan taken against the value of the death benefit must be paid back. No loan option is offered in ownership of a Mutual Fund and distributions made from a Mutual Fund have tax implications. Conversely, cash value accumulated in a life insurance policy is tax deferred.
COLLABORATE WITH A TRUSTED ADVISOR
The selection of diverse investment vehicles involves understanding all your options thoroughly. A trusted fiduciary can assist you to weigh all of your options that are in your best interest in your particular situation to allow you to make educated choices for you, your family and your child.
All the very best to you,
Jan Attard, MBA, RIA, Wealth Accumulation Specialist
Technical & Fundamental Market Analysis
J. Oliver Maxwell, LLC