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Life insurance for children?
My mother wants to buy my baby a life insurance policy, but I'd prefer a college fund. Who's right?
April 5, 2005: 11:26 AM EDT
By Walter Updegrave, CNN/Money contributing columnist

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NEW YORK (CNN/Money) - My wife and I recently had our first son and my mother wants to buy him a $50,000 life insurance policy. But when I tell her I think it would make more sense for her to contribute to a college savings plan or custodial account in his name, she makes it sound as I'm a lunatic. We are fighting mad at each other at this point. So I ask you: am I right on this or am I a lunatic?

-- Rhoads Hall, St. Louis, Missouri

For all I know you may be a lunatic. But it's not because of your position on life insurance for children. At the risk of flinging myself into what appears to be a highly volatile family brouhaha, I have to say that from a purely financial point of view, I agree with you on this one, for a variety of reasons.

First, the main reason to take out a life insurance policy is to replace that person's income should he or she die. So if you earn, say, $50,000 a year, you'd want to have enough life insurance to replace some portion of that income so your wife and son would be able to live decently after you're gone.

Even if a spouse doesn't work outside the home, there's a good argument for insuring his or her life. If that person were to die, you would have to pay someone to provide the non-working spouse's duties -- child care, cooking, cleaning, etc. -- at least for some period of time.

But unless you expect that your infant son will earn money that the family will depend on -- doing TV commercials, baby modeling or whatever -- then I don't see a financial reason for a life insurance policy on your son.

Don't insure against probably-nots

Some people claim -- and most of them are insurance agents -- that buying a life insurance policy on an infant or youngster is a good idea because insurance is a wonderful investment since the money inside the policy builds up free of income taxes and you can borrow against the policy's cash value.

Others may say it's a great idea to take out a life insurance policy early on in case your son has health problems later on that make it difficult or very expensive to insure him.

I disagree with the investment argument because you're paying a lot in sales and marketing charges when you buy a cash value policy. As for buying now as a preemptive strike against possible future health problems, I'd say that unless you have some advance knowledge that your son will have serious medical problems in the future that aren't apparent now -- in which case the insurance company would find out about them if you take out a policy of decent size -- I'd say this is shelling out money for an event that has very low odds of coming into play.

Save for college

All of which is to say that I think your mother would be doing better by your son if she invested in a 529 college savings plan, a Coverdell Account or a Uniform Transfer to Minors Account, aka a Uniform Gift To Minors Account. (To compare the pros and cons of all three, click here.)

In fact, since these options can affect how much financial aid your son may qualify for down the road, your mother might be better off investing the money in her own name for your child or, for that matter, giving it to you to invest in your name. You could always mitigate the tax bite by investing in index or tax-managed funds.

I can't stress enough that I'm giving you my financial take on your situation. This could be one of those cases, however, where trying to do what's best financially could cause bigger problems in other areas.

So I think you need to think long and hard about whether to challenge your mother on this. You certainly wouldn't want to anything that would jeopardize your relationship with her or her relationship with your son. It sounds like she's trying to do something nice for her grandson -- and it is her money.

You'll have to come to your own decision. But if it were me and my mother didn't come around after my initial objections, I'd let her do what she wants, and thank her for it.

If that makes me a lunatic, so be it.

Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."  Top of page


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