If you buy through our links, we may earn money from affiliate partners. Learn more.
A few years back, I worked as a financial advisor for a broker-dealer here in Minneapolis. When you start as an advisor with most firms, they encourage you to not only contact your family and friends, but to also do an overview of your own financial situation to determine what gaps you may have.
My husband and I were quick to buy life insurance for ourselves as we knew we wanted kids in the near future, but after our first child was born, we were also encouraged to buy a life insurance policy for her.
While there are reasons it makes sense to get a life insurance policy on a child, it’s important to understand why you are purchasing it and how the policy works. The policy we went with was a $50,000 “20-Pay Whole Life Insurance Policy.” This meant that the death benefit was $50,000 and it was set to be “paid off” in 20 years.
Why we bought a whole life insurance policy for our daughter
One of the reasons we purchased this policy was the ability to guarantee our daughter’s insurability in the future. This meant that if she were to have some sort of medical diagnosis that prevented her from getting life insurance coverage when she was older, she would at least have the insurance policy that we bought for her when she was an infant and could have the option to add more insurance to it in the future.
More so, however, we purchased this policy so that the cash value component could be used to help pay for college.
We had our daughter’s policy set up so that it would be fully paid off by the time she graduated high school, and then she could decide to either keep the policy or surrender it and access the cash value to pay for school or another endeavor. After doing more research and taking time to contemplate, though, we decided there was a better option for the funds we were putting towards this policy.
We reconsidered when we thought more about the policy’s actual cash value
Whole life insurance policies are oftentimes purchased because of the potential cash value they offer. Although these cash value components can look really promising, it is important to understand that they are not guaranteed.
For the policy we purchased for our daughter, the cash value component was tied to dividends, which are based on the company’s number of death claims, investment earnings, and expenses, and thus can change over time. Beyond the amount that is guaranteed, the amount of cash value can vary greatly.
Last year, it dawned on me that maybe we didn’t make the right decision by purchasing a whole life insurance policy for our daughter, but we paid the premium and decided to hold onto it for one more year. This year, however, we’ve decided to surrender the policy.
Although this policy could potentially be beneficial to our daughter in the future if she were to somehow become uninsurable, we are more interested in investing the premium money into an account that is sure to experience more growth and that she can use for education, starting her own business, homeownership, or something else that will help her meet her own future financial goals.
We’re investing in a brokerage account for our daughter instead
At the time of this article’s writing, the cash value in our daughter’s insurance policy is $370.70. We’ve only paid two years’ worth of premiums at this point, and so although we will technically be “losing money,” we still feel this is the right choice for the goals we have for our daughter.
The premium for this policy is roughly $540 per year, and if we invest only that amount into a brokerage account, the account could grow to $17,279 by the time our daughter turns 18. This is based on a 7% average rate of return. Our plan is to invest more than the $540 per year into that account, so she will have more than $17,279 after she graduates from high school.
On the other hand, by the time our daughter graduates high school, the guaranteed cash value of the insurance policy would have been just $5,053. In order to reach a guaranteed cash value of over $17,000 she would have had to wait until she was 51 years old!
There are different types of investment accounts to choose from, but we are in the process of opening up separate brokerage accounts through Fidelity for our two kids. Although we could have set up a