by John Bearss
Today, I would like to answer a listener’s question, “Should I Buy Whole Life Insurance or an Annuity For My Grandchildren?” If your goal is to accumulate money for a grandchild (or a child), both options are good, but let’s look at the pros and cons of each strategy.
There are many factors in this decision, but first ask yourself a few questions.
1. What is the age of the grandchild?
2. What is the money going to be used for?
3. When do you want the grandchild to have access to the money?
4. Do you want to keep ownership, or do you want the grandchild to have ownership of the money?
Let me give you just a few of the pros and cons of life insurance vs an annuity.
Whole Life Insurance for Grandchildren
If the grandparent does not want to give up ownership, then they should retain ownership of the policy. Obviously, this will trigger various tax issues. The advantages to the life insurance policy are:
Tax-Free Gifts: The grandparent could take loans against the cash build up within the whole life insurance policy and then gift the cash to the grandchild with no tax ramifications.
Tax-Free Death Benefit: If the grandparent passes away, the death benefit would be paid to the grandchild income tax free. This is assuming that you named the grandchild as the beneficiary. In this instance the grandchild would have a greater amount of money than the cash value inside of the life insurance policy.
The drawback to the life insurance would be that you need to give this contract several years to grow because there typically is not much cash build up in a life insurance policy in the early years. This is because, like a home mortgage, the majority of the premiums you are paying in the beginning does not all go towards the cash value. Some of the premium will pay mortality costs for the life insurance and administrative costs. (If you are interested in getting a 100% free customized example of how the cash value will build tax-free within a whole life insurance policy, send me a quick note in the question box below. I’ll contact you and get some basic information so I can run an illustration for you.)
Annuity for Grandchildren
If the money is going to be used for the grandchild before he or she reaches the age of 59 ½, then an annuity contract owned by the grandchild would not make much sense because they will pay income taxes on the interest earned in the annuity contract the year they take receipt of the money.
Also, there would be an additional 10% penalty of that interest earned by the Federal government if they are not age 59 ½ for early distribution.
So an annuity contract owned by the grandchild with the purpose of using the money before they are age 59 ½, would not be as lucrative after the tax ramifications are applied. Clearly the purchase of a life insurance policy where the grandchild could take loans against the cash value, income tax free is typically a more appropriate choice.
If the money is placed into an annuity contract that is owned by the grandparent above the age of 59 ½, income taxes on the interest earned in the annuity are due in the year they took the distribution. However, if the grandparent is in a high income tax bracket, this could be detrimental.
Here’s one “what if” question to ask yourself: What if the grandparent died early before the cash value had a chance to grow in either the life insurance or the annuity? In this case, the life insurance would have been a much better way to go because the death benefit goes to the grandchild income tax free.
There are many more scenarios that we could get into to help you make the decision that is right for you. So if you are wondering, “Should I buy whole life insurance or an annuity?”, be sure to consult a trusted financial advisor, who will cover all the details of your specific situation to help you make the right choice for accumulating money for your grandchildren.