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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.

Banking, Mutual Funds, Real Estate, Insurance
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February 2019

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.

February 2019
February 2019