Life Insurance For Children – Episode 266

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[00:04] Welcome to the Prosperity Podcast. Fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler. Welcome to the Prosperity Podcast. Today, we’re going to be speaking about life insurance for your children. And we’re going to talk about how much you should be doing for a life insurance policy, when you should be doing it, or maybe if you should be doing it. Kim, are you there with me? I am, Spencer. Happy to have this conversation. This is actually a fun conversation because, you know, it’s one of those where I think unless you’re extremely proactive, this is one of those conversations where you’re looking back or maybe you’re looking at some of your younger children saying,

[00:52] OK, this is something I need to do now. And then you feel urgency. So first, let’s talk about the question of when you should get life insurance for children. Well, this is a very hotly debated question among life insurance agents, I’ll have you know. And the typical, for example, property and casualty agent that’s going to just throw in life insurance as an afterthought, they would recommend, you know, maybe a 10 or 20 thousand dollar policy. And it’ll basically be, you know, it might be whole life, but it’s basically a burial policy. Just, oh, my gosh, the, you know, heaven forbid, unforeseen thing happens and your child dies and now you have some money. And that’s not how we look at it at all.

[01:39] We know that death is a guaranteed event and we hope it’s hundreds of years from now, literally, at least 100 years. Right. From a typical child. So it could be grandchild in this particular listener’s eyes or ears. But we’ll just use the word child for today’s discussion. And yet there is for that child’s entire life, one singular need that I’m going to address that you as the parent or grandparent can set that child up for in the most efficient manner for their entire life. One thing. So I’ll put you on the spot, Spencer. Can you guess what it is? Can I guess the one thing? I’m going to take a stab at it. Go for it. Saving. Saving. Yes. And now I was going to, I was going to use the word cash, but I’ll give you

[02:33] half credit for it. Is that a deal? That works for me because saving has both a noun and a verb related to it. Right. Saving is an act and you are a hundred percent correct if what you meant by that is the act of saving the literally forced act of having a bill to pay called the life insurance premium, which is building cash and cash value is what it’s called actually. But liquid cash, the particular cash value that gets built is the most efficient place to store liquidity. And as we know, every single person, no matter what their situation is, no matter how many zeros should or should not be on said cash account needs a liquid place to store cash. And so saving as a verb is a very critical act.

[03:24] Savings as a noun, like the actual savings account is also super, super important because if you’re going to save as a verb, then you need to have a place to store your savings like a noun and the cash value of life insurance is the best place to do that. So when we look at life insurance on children, we’re looking at setting them up with a liquid cash value account that can be their emergency opportunity fund for the rest of their life. And if you got over the fact that it was life insurance and that there was a death benefit, et cetera, and just set that aside for the time being, and all you focused on was the fact that this particular child as they grew up and got into their adult lives would have a place that

[04:14] I’m going to use my little four letter acronym called Clue, C-L-U-E. So they would have a place that they could completely control. There would be a hundred percent liquid that could be used for whatever they wanted and that would act like equity, meaning they could borrow against it. C-L-U-E control liquidity, use and equity. Then that, at least from my perspective is something that every parent and grandparent would want their children and grandchildren to have. Okay, so you started out and you said that the typical, and I’m using the word typical, financial planner, whomever that would be, would say, hey, you need 10 to $20,000 and they’re focusing on the burial. So for you, you’re more of the traditional and you’re looking

[04:57] at it differently, how much should a person be doing that for? Probably a hundred to 250,000, maybe even up to 500,000. So of course, the first step is probably going to be a smaller policy. Let’s call it $100,000 and you’re putting in maybe, I don’t know, a thousand, 2000, maybe $3,000 a year. Once you really understand it, you’re going to want to bump that up. But interestingly enough, there’s a limit to how high you can bump it up. So maybe your first policy is a hundred grand. The second one’s 250, maybe 500, like I mentioned, but you cannot get a $500,000 policy on your child unless you have at least double that. If not more often, triple or quadruple that on yourself. So what I mean by that, if you’re going to want to buy a half a

[05:50] million dollar policy on your child, you probably need to have a couple million, four times is the best rule of thumb that I can give you. Four times the death benefit for the parent to have on themselves versus 25% of that, the opposite on the child. So if I have $4 million of death benefit on myself, I can get up to a million dollars of death benefit on my child. It’s a rough rule of thumb, but that’ll give people a little bit of guidance. Now, of course, if I’m going to do that, my four million doesn’t have to be all whole life, but probably some of it should be. And my million that I’m going to, if I chose to use that analogy, that I would buy on my child should probably be all whole life.

[06:39] So I don’t know that I would really see somebody buying term insurance on a child. I mean, you could argue that there might be some reasons why. So what that means is if you don’t have the cash flow for a million on your child, then you shouldn’t be doing it at that level. You want to make this decision based more on your own cash flow, your ability to save, like we started talking as a verb early on in this podcast, that’s really where you want to make this decision. Okay. So you’re saying anywhere between a hundred thousand to maybe even five hundred thousand, but the rule of thumb is four times. Does that seem a little excessive? So let’s be clear on the rule of thumb. The rule of thumb is 25% of your own.

[07:23] So whatever the child has, you need to have four times on yourself. So yes, absolutely. You could say that it’s excessive, but let’s look at this and ask this question. Is a life insurance company ever going to allow somebody to be insured for more than they are worth? What do you think the answer is? Is a life insurance company ever going to allow somebody to be insured for more than they are worth? Well, it seems like on the child, yes, but I would guess because of the having it at 25% and they’re taking into the parents factor and everything else, longevity reasons, no, is that how it works? That is correct. So this introduces a concept called human life value, and there are basically two schools of thought as it relates to the amount of life

[08:20] insurance that is appropriate for somebody. One school of thought is called the needs analysis. So let’s set the children aside for a minute. This is much easier on a working adult. The needs analysis says, okay, Spencer, if you had died yesterday, do you want to replace your income, pay off the mortgage, educate the kids, et cetera, et cetera, et cetera. And a big calculation is made and a quote need is arrived at. And that need is a certain dollar figure based on how you answer the questions, do you want to replace your income, pay off the mortgage, educate the kids, et cetera. The other school of thought is the human life value, which is more of an optimization or a maximization approach where it says you as an economic working

[09:07] person, a human being in the working world are worth something called human life value that we can use a rule of thumb on and it’s a function of your income or your net worth and it has absolutely nothing to do with the need. And so the rule of thumb is 15 to 30 times your income depends on if you own a business and some other things. So let’s just use easy math and say it’s 20 times. So if you earn a hundred thousand dollars, your needs analysis might say that you only need a million dollars of insurance again, depending on how you answer the question, the human life value analysis is going to say the maximum amount of life insurance that you can get would be 2 million, 20 times your $100,000.

[09:54] And so when you take that into consideration and you bring it back to a child who’s clearly not earning an income, you can see why it’s a function of the adult’s amount of life insurance, because the adult may or may not have their human life value, you know, the adult may have done needs analysis and capped it at that amount. And on another podcast, we can talk a little bit more about the difference between needs analysis and human life value, but let’s just suffice it to say that human life value is a much more accurate approach to a guaranteed event called death that we are looking to ensure and furthermore, human life value has another rule of thumb. So I mentioned it’s 20 times income or one times your gross worth.

[10:44] So gross worth, not net worth. In other words, we’re not going to reduce your value by the debt. We’re going to just look at your gross worth. And so here’s something that’s very interesting. There are trust fund babies, right? They’re babies that are born into families that are wealthy, where literally the day that they’re born, they’re worth $10 million or whatever their trust is worth. You follow? I do follow and I’ve met them. That baby, literally a one year old or less, could be in could be insured for $10 million. Whereas a baby born into my family, for example, could only be insured for a million or a million and a half based on the amount of insurance that I have, because my child’s gross worth is effectively

[11:30] zero, whereas a trust funds baby’s growth gross worth, it’s not an easy thing to say, is 10 million. So this is actually proof that a life insurance company will not ensure anybody for more than they are worth, but they will ensure up to maximum human life value, which again is 15 to 30 times income or one times gross worth. And then for a child, it’s about 25% of that number of whatever the parents human life value is. That’s very interesting. Now there’s one kind of looming question out there that some of our listeners may have and they’re thinking, okay, well, I get this life insurance and for all of us that are of age, we have to do one thing, which is a medical. So what about a medical for children?

[12:25] Yes. I’m glad you brought that up. Typically the pediatrician’s records are requested, which of course the parent has to sign that those can be shared and that’s it. If the child is under kind of depends on the company, either 16 or 18, some of them even under 14 and again, depends, then all that happens is the pediatrician’s records are requested once you get into that teenager realm, sometimes a physical exam will occur or the insurance company will just ask that the child’s present when the adult physical exam is getting worked on. Cause oftentimes we’re doing these things together, but if you’re talking about anybody under 14, no physical exam. Okay. And since there’s no physical exam, how does that affect the policy?

[13:10] And I guess what I’m getting to is doesn’t this lock in their good health for the long length of their life? Ah, how smart of you to bring that up. So yes, the pediatrician’s records, you know, were there a problem would reflect that problem and the insurance company could decline the coverage and thankfully this does not happen very often and so it does lock in that child’s health for the rest of their life and that’s a very important additional element to the importance of the place to store cash because there are sometimes children that in their late teenage years developed some type of issue that could cause them to be uninsurable for a period of time or potentially even the rest of their

[13:54] lives and thankfully while this doesn’t happen often, it is something to be aware of and something that you can do for your children in buying life insurance on them when they are young, thereby locking in that good health and also that age and I want to address this as we’re wrapping up here because there is a misunderstanding I think about life insurance on children. People think it’s going to have a massively higher internal rate of return. What internal rate of return means is the growth of that cash value net of the cost, so minus the cost of the death benefit, the cost of the commissions and the cost of running the company. Well, the net net net internal rate of return on a let’s call it a

[14:38] 10 year old child right now today’s world is around three and a half to four percent and just by comparison sake, the net net net return on say a 35 or 40 year old healthy person is probably around 3.2 to 3.5 percent. In other words, there’s a little bit of an improvement, absolutely, but not as much as people sometimes think. So again, circling back, buying life insurance on your children, good place to store cash, good place to create forced savings and good place to protect their health for the rest of their life and then at another podcast, we’ll talk about the importance of that death benefit and what it can actually do for them way out in the future yet prior to their death. So that’ll be a fun conversation to put down as a note for a future

[15:36] podcast. We’ll definitely do that. And, you know, listeners, if you happen to have children, grandchildren, and you’re wondering when is the appropriate time or how to set it up or how much coverage, the best thing you can do is reach out to Kim at hello at partnersforprosperity.com. It’s something that all of us, if we have those children or grandchildren, we’re constantly thinking about. And if you already have a policy, maybe it makes sense to add another one if the cash flow is working for you. Again, thanks for listening to the podcast today. Submit your questions at hello at partnersforprosperity.com. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us

[16:22] at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.