Thursday, August 14, 2008

Life insurance for babies?

Yesterday, I received a letter from a life insurance company offering me a whole life insurance policy on my six-month-old daughter.  I can hardly think of a product that I need less.

Life insurance is a fantastic product that is used to help alleviate the financial burden created by the death of a family member.  While any death in the family is emotionally devastating, the death of your spouse can also be financially devastating.  Most six-month-old children (my daughter included) don't bring home a salary or offer much help around the house.  While the death of a baby would be absolutely heartbreaking, there is nothing that about the loss of a baby that a few thousand dollars can replace.  While life insurance money will not replace a spouse, it will help fill financial needs created by the loss.

Furthermore, life insurance for a baby is incredibly expensive.  The rate that this company is offering is $3.18/month for $5,000 of coverage.  By way of comparison, my term life policy costs me 23 cents/month for $5,000 of coverage.  I know, this isn't a fair comparison - whole life insurance builds up cash value.  Lets take a look at how that cash value builds up:

The letter I received claims that after 25 years the policy can be cashed in for the amount of premiums that you have paid in.  This cash value is one of the main benefits of the policy.  The company suggests that once your child is 25 you can give them this money as a nest egg.  Assuming that you purchased this policy the month that your child was born, you would have paid in $954 in monthly payments over those 25 years.  So you will end up with 25 years of insurance coverage (which you didn't need) and $954 which grew at a rate of 0%.

Lets take a look at what would happen if instead of purchasing the insurance policy, you invested the money in a low cost mutual fund for your child.  If you took the same amount of money - $38/year - and invested it at an 8% annual return, when your child is 25 your investment will be worth $3,000.  Which one do you think your child would prefer?

My advice: skip the life insurance policy and start saving for college.

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