The primary function of life insurance is to protect dependents from financial loss in the event of the insured's death. Consequently, it makes little sense to take out a large life insurance policy on a newborn baby, as no one depends on babies financially. Buying a smaller policy for a baby can offer advantages in certain situations, such as providing for burial expenses in the event of a worst-case scenario.
How Life Insurance Works
A life insurance policy pays a sum of money to a named beneficiary if the insured dies while the policy is in force. The owner of the policy pays a premium for it, usually monthly, to keep it active.
The two main types of life insurance are term life insurance and whole life insurance. Term life insurance pays only if the insured dies within the defined term, such as 10, 20 or 30 years. If the insured outlives the term, the policy expires without paying or, in some cases, the owner can convert it to a whole life policy. A whole life policy stays in force as long as the premiums are paid.
Because most term life policies never pay a death benefit, the premiums are much cheaper than for whole life policies, which always pay unless the owner lets them lapse. For example, a 30-year-old male nonsmoker in Florida can obtain a $100,000 term life policy covering 20 years for about $9 per month. A whole life policy with the same death benefit would cost him $50 per month or more.
While term life insurance offers the most protection for the lowest cost, some people gravitate to whole life insurance because it doubles as an investment vehicle. A portion of each premium payment goes into an account that grows with interest over time. The amount of money in this account is known as the policy's cash value. The policy owner can borrow against this money or even redeem his or her policy for it, effectively forgoing the death benefit. Historically, return rates on whole life insurance have been low, which is why many investors prefer to pay the cheaper premiums of term life and invest the difference in mutual funds.
Babies and Life Insurance
Life insurance comes in handy when a person's income supports other people, such as a spouse and children. If the breadwinner dies unexpectedly, his or her dependents face an income loss and potentially cannot afford to continue living the same lifestyle. Household finance experts recommend buying enough life insurance to see dependent children through to adulthood. For example, a person making $100,000 per year whose youngest child is 10 needs $800,000 in life insurance to provide until the child is 18.
Because babies do not earn incomes, no one depends on them financially. While a parent losing a child is as tragic as a child losing a parent prematurely, a family in the former situation does not face a loss of income from the baby. On this account, buying an expensive life insurance policy on a baby is unnecessary and a waste of money that could be put toward more useful expenses, such as saving for college.
When Life Insurance for Babies Makes Sense
There are a couple of strong arguments for buying at least a small life insurance policy for a newborn. The first is having money available in case the absolute worst happens and the parents are forced to bury the child. The average funeral costs between $7,000 and $10,000, as of 2015. Many adult life insurance policies offer child riders for only a few dollars a month, which can offer a little peace of mind in the event of a tragedy.
In addition, life insurance is less expensive the younger the insured is. Some parents prefer to lock in a low premium so that the baby has inexpensive coverage for himself or herself when he or she becomes an adult. Others feel that it is better to invest this money in a more traditional vehicle with stronger growth potential and greater flexibility.