Fund Your Children's Retirement Now
As a parent, one of the many challenges you face is finding a way to ensure your child’s financial security over the course of a lifetime. In planning for this goal, it’s important not to overlook the role that Universal Life insurance can play.
While the notion of buying Universal Life insurance for a child may have morbid overtones for some, it can be a very effective wealth transfer strategy and a worthy choice of additional savings for a child or grandchild’s benefit.
The tax efficiency and attribution rules of Universal Life insurance, combined with a long time horizon, allows parents and grandparents to build a substantial nest egg that can be used by their children or grandchildren when it comes time for them to retire.
Life Insurance Can Enhance Your Child's Future...Today
The mechanics surrounding the use of Universal Life insurance to fund a child’s future retirement are relatively straightforward. A grandparent or parent applies for a life insurance policy as its "owner" and names the child as the insured. The owner of the policy names a beneficiary for the policy’s death benefit which can be the same as the owner or different. A grandparent may choose to name the parents as the beneficiaries for example.
In the case of children, insurance companies rarely require an extensive medical exam. Usually, only a simple medical questionnaire is completed unless the amounts of insurance are very high. However, insurance companies will request that the parents of the child be adequately insured before considering issuing a policy on the child.
Once the policy is approved the owner will then pay the insurance premiums. The reason that a Universal Life policy would be used is the ability to shelter additional dollars within a tax-sheltered environment beyond the minimum premiums required to fund the low insurance costs for the child. Depending on the face amount of the insurance policy and the age of the child, significant additional dollars can be committed to the policy, which can then be invested in a variety of investment funds to grow over the life of the policy, tax-sheltered.
As outlined in the case study, we show how a five-year-old is provided with a life insurance policy in the face amount of $600,000. The parents invest $35,000 over five years, with the goal that when the child reaches age 55, he or she may borrow roughly $28,800 per year against the Universal Life Policy, with no tax implications for nearly 15 years. The total amount borrowed, plus accumulated interest, during that period would be $922,788.
There are a few guidelines to keep in mind before investing in a Universal Life policy for a child or grandchild. This investment strategy is best suited for parents with young children (pre-teens) or grandparents with young grandchildren. Parents and grandparents must also ensure that they’re financially secure themselves and don’t require the funds for their own retirement – they should have the ability to contribute $5,000 or more per year, per child to an investment vehicle for five or 10 years.
Purchasing life insurance for a child may seem excessive, but when you consider the potential wealth transfer effect emerging with significant estates being passed down to the next generation and their inherent future tax liabilities, the concept is not that farfetched. In fact, funding your children’s retirement now is an extraordinary gift that can have both significant and long-term investment and insurance benefits.
Universal Life Insurance for Children
- The parents are financially secure and are concerned about the financial future of their five-year-old child
- The parents invest $35,000 over five years ($7,000 per year)
- When the child reaches age 55, he or she may borrow approximately $28,800 per year against the Universal Life policy, with no tax implications for nearly 15 years. The total amount borrowed, plus accumulated interest, during that period would be $922,788
- If the child dies at the age of 80, the outstanding balance on the loan will be roughly $2,381,181. However, the death benefit will be $3,727,959, which is more than enough to cover the outstanding loan and accumulated interest costs
- Upon death, the net estate will remain with a value of $1,346,778 tax free
- Assumed bank loan rate of 9%
Note: The underlying product in this case is Universal Life and the illustration was made using an annual rate of 6% and compared with an alternative investment at 7%. The Universal Life outperformed the alternative investment in the fifth year. Figures are for illustrative purposes only and don’t reflect future results.
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