An Alternative Children’s Saving Strategy
By: Robert Nabel
I know what you are thinking, “Life insurance for my child?” What an appalling idea! So why do my financially savvy clients procure life insurance for their kids? Why would they put their money into a macabre financial vehicle such as this?
Well for starters, it is because they are frustrated with how a savings account accumulates money. The next to nothing interest rate of a traditional savings account is atrocious, comical, and downright offensive. Did you know, a traditional bank account earning a yield of .1% would take almost seven hundred years to double from one hundred to two hundred dollars? In seven hundred years what will two hundred dollars be able to buy you with inflation eroding the purchasing power of your money? If you aren’t familiar with the idea of inflation just remember that a Big Mac from McDonald’s in 1960 cost 21 cents and today, it’s $3.99. Imagine the price of a Big Mac seven hundred years from now. My guess is that same two hundred dollars will buy you just one of these delicious sandwiches from The Golden Arches.
The reason people use these vehicles as banking alternatives is because the cash value growth inside an insurance policy from a Mutual insurance company. The reason I only use Mutual companies for juvenile life insurance policies is that when you own a contract from one, you essentially own part of the company and are able to take part in the yearly profits of said company, further increasing the cash value inside of the policy. These policies are guaranteed to grow at a 4% internal rate of return over the life of the policy, plus the yearly profits in the form of dividends. It is important to note that these dividends are not guaranteed. (Julia Kagan, 2020)
The cash value inside of one of these contracts is not “earmarked” towards anything. What I mean by this is the Government does not have any say in how and when you spend your money, as opposed to a 529 college savings plan which is intended to be used for higher education. If it is not used for qualified education expenses, there is a 10% penalty as well as ordinary income taxes on the growth (Sec.gov, 2018). There are no restrictions on such a contract so the owner of the contract, usually the parent, can use this money for anything they see fit. They can use it for college expenses, purchase their first car, a down payment on a house, a wedding present, or seed money to start their own business!
This money does not get reported to the IRS so, if structured and distributed properly, the growth of the cash value can be accessed tax advantageously. When applying for financial aid for college, the admissions department looks at all the assets of the parents but not this. You could have a 100k account value inside your policy and the financial aid offices would not consider this. This is in stark contrast to having 100k in a 529 savings plan as it would get reported and your child would most likely receive less, if any, financial aid. So, when Grandma and Grandpa set up a college savings plan for their little munchkins, they might want to look outside of Wall Street and state sponsored programs to do so.
Juvenile whole life insurance policies are not correlated to the stock market so there are no fluctuations in the cash value. Once the dividend is declared and put into the contract, it only leaves when you pull it. You could access the value in the form of a loan which you may (but do not have to) pay back. The biggest reason people fund policies like this is access to capital. (Julia Kagan, 2020)
Another huge reason why people do this for their offspring is because it guarantees insurability for the future. The fact of the matter is we don’t know what the future holds for us, whether it be illness or perfect health. My clients prepare for the worst with the hope of the best. When they do this kind of planning, they are able to insure their love for future generations. Even if the child becomes uninsurable, they are still able to purchase insurance at set interval dates. As an example, my best friend is uninsurable, however thankfully his parents had some forethought and purchased life insurance for him at the ripe age of 2. He is now 27 years old, has a family and was able to purchase additional life insurance. He can make good on his promise to protect and provide for his family.
So, with all this said, does it make sense for you to fund a life insurance contract for one of your children? The choice is yours. But, if you are like my financially astute clients, you think so. If you see the value in giving your child the ability for financial advancement, to live the life they want, based on choice, and not circumstance, then you would think so too.