Single premium life insurance

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Choosing life insurance can feel overwhelming with all the different options available. One type that stands out for its unique structure is single premium life insurance, which usually refers to a permanent life insurance policy. Unlike traditional policies that require ongoing payments, single premium life insurance is funded with one lump sum payment, ensuring a guaranteed death benefit. This simplicity can be appealing, especially if you prefer not to worry about future premiums.

Imagine securing your loved ones’ financial future with just one payment — no more monthly bills or annual renewals. But, before you commit to such a substantial upfront investment, it’s helpful to understand both the perks and potential drawbacks. With our expertise at Bankrate, we’ll guide you through everything you need to know about single premium life insurance, helping you decide if it’s the right fit for you.

What is single premium life insurance?

A single premium life insurance policy (SPL) is funded by a one-time, upfront lump sum payment, providing a guaranteed death benefit to the policyholder’s beneficiaries. Unlike most life insurance policies, such as term life insurance, that require ongoing premiums — whether monthly, quarterly or annually — SPL policies simplify the process by requiring just one payment. This strategic approach allows the policyholder to build cash value quickly, which can be accessed through policy loans or withdrawals, offering a financial resource during their lifetime.

Single premium life insurance is often favored by high-net-worth individuals for its accumulation benefits rather than for income protection, which is the primary goal for most life insurance buyers. This type of policy is particularly useful for those looking to maximize their investment quickly. While term and whole life insurance policies typically necessitate regular premium payments over a specific period, single premium life insurance eliminates the need for ongoing payments, providing a straightforward and efficient option for securing a substantial death benefit and building cash value.

A single premium option is available under three different forms: single premium whole life, universal life and variable life insurance.

• Single premium whole life. This falls under the whole life insurance umbrella, which is a type of permanent life insurance. With single premium whole life insurance, you make a lump sum payment toward a policy that builds cash value over time and earns a specified amount of interest.
• Universal life. A single premium universal life insurance policy is similar to whole life insurance because the policy’s cash value is guaranteed to grow. The difference is that universal policies are typically more flexible and accumulate cash value in a different way than whole life insurance.
• Variable life insurance. A variable life insurance policy also builds cash value, but the cash value grows at a variable rate. You have limited options in how to invest, such as in mutual funds, but your policy can over- or under-perform in the market.

Pros and cons of single premium life insurance

Because there are numerous life insurance options available and a single premium life policy requires a large upfront investment, you should understand both the pros and cons of selecting this policy.

Pros of single premium life insurance

• Single payment: One of the most significant advantages of single premium life insurance is the convenience of a one-time payment. By funding the policy with a single lump sum, policyholders eliminate the need to worry about ongoing premium payments. This approach simplifies the financial planning process and ensures that the policy remains in force without the risk of lapsing due to missed payments.
• Faster cash value accumulation: Single premium life insurance policies offer immediate access to cash value, unlike traditional policies that can take years to accumulate sufficient cash value for access. This immediate cash value can be a vital financial resource, allowing policyholders to take loans or make withdrawals as needed. The accelerated accumulation is particularly beneficial for those looking to leverage their policy for investment or emergency funds.
• Guaranteed death benefits: With a single premium life insurance policy, the death benefit is guaranteed from the moment the policy is funded. Since the policy is paid up immediately, there is no risk of it lapsing due to non-payment. As long as no substantial loans or withdrawals diminish the policy’s value to the point of termination, beneficiaries are assured of a tax-free death benefit. This guaranteed payout provides peace of mind, knowing that financial security for loved ones is firmly in place.

If you are doing well financially and want to be able to have your life insurance policy fully paid for your beneficiaries’ sake, single premium life insurance may be a choice well worth your consideration. This method of obtaining life insurance also offers peace of mind from its transparency on what to expect in the future in terms of policy value and payout.

Cons of single premium life insurance

• Large upfront payment: One of the main drawbacks of single premium life insurance is the significant lump sum required to fund the policy. This large initial payment can be a financial burden for many, making it less accessible for those without substantial savings.
• No refund if insured dies prematurely: If the insured person passes away shortly after purchasing the policy, there is no partial refund of the lump sum payment. This means the policy owner ends up paying more than they would have with regular, smaller premium payments over time. It’s like paying upfront for a lifetime gym membership, only to find out that circumstances prevent you from using it shortly after.
• No additional contributions allowed: Unlike other life insurance policies that allow you to make additional contributions over time, single premium life insurance does not offer this flexibility. Once you make that initial payment, you can’t add more to the policy later on. This lack of flexibility can be a downside if your financial situation changes and you wish to invest more in your policy.
• High surrender charges: If you decide to cancel the policy early, you may face high surrender charges. These charges can significantly reduce the amount of money you get back, making it a costly decision to terminate the policy prematurely. It’s similar to trying to back out of a long-term contract and facing hefty penalties for doing so.
• Tax issues: Single premium life insurance policies are typically classified as Modified Endowment Contracts (MECs). This classification comes with specific tax implications, particularly regarding the treatment of loans and withdrawals from the policy. While MECs can offer some tax advantages, they also bring potential tax liabilities that you need to be aware of. We’ll delve deeper into these tax issues later, but it’s important to know they exist upfront.

If you don’t have a nest egg on hand to pay the SPL premium costs upfront, there are other payment options for obtaining life insurance. Paying for life insurance in monthly payments is one of the most common choices. Being able to pay for your life insurance policy in installments may also be the best option for your beneficiaries’ sake because it could allow you to afford more insurance coverage through a multiple-payment option. Policies with a multiple-premium payment option can still provide you and your beneficiaries with peace of mind about what to expect in terms of financial security when the policy is paid out.

What is a modified endowment contract?

A modified endowment contract (MEC) is a type of life insurance policy that has special tax rules. This happens when a life insurance policy, such as a single premium life insurance policy, is funded too quickly with too much money. Here’s what you need to know:

1. Single payment policies: Single premium life insurance involves paying one large lump sum upfront, which fully funds the policy. This is different from traditional policies where you make smaller payments over time.

2. IRS rules: The IRS has rules to prevent people from using life insurance policies as tax shelters. One of these rules is the “seven-pay test.” This test compares the money you put into the policy in the first seven years to a certain limit. If you put in more money than allowed, your policy becomes an MEC.

3. What happens when it’s an MEC:

• Withdrawals are taxed: Normally, with life insurance, you can withdraw up to your cost basis (typically the sum of premiums you’ve paid) without being taxed. However, on an MEC contract, withdrawals are taxed as ordinary income on a last-in-first-out (LIFO) basis.
• Loans are taxed: Taking a loan against your policy’s cash value can also be taxed, and if you’re under 59½, you might have to pay an extra 10 percent penalty.

4. Why it matters: If your policy is classified as an MEC, you lose some tax advantages. This doesn’t make single premium life insurance bad, but it does mean you need to understand the tax implications.

In summary, a single premium life insurance policy can become a modified endowment contract because it is fully funded upfront. This changes how the policy is taxed, particularly when you access the cash value. Knowing this can help you make better decisions about your life insurance and overall financial plan. If you have any questions, it’s a good idea to talk to a financial advisor who can explain how these rules apply to your situation.

Is single premium life insurance worth it?

Single premium life insurance can be a valuable option for specific financial situations. Here are some scenarios where it might be worth considering:

1. Inherited money and life insurance needs: If you’ve recently inherited a sum of money and need life insurance, a single premium policy can provide immediate coverage without the need for ongoing payments.
2. Wealthy individuals: For those who have already maxed out their retirement accounts like 401(k) and IRA, a single premium life insurance policy can be a way to further diversify and secure their financial plan.
3. Estate planning: For individuals with large estates, this type of policy can help reduce estate taxes by using part of their assets to purchase life insurance. This can ensure that heirs receive more of the estate’s value.
4. 1035 exchange: If a policyholder has a policy (or policies) with significant cash value and no longer wants to pay premiums, they can do a 1035 tax-free exchange to a single premium paid-up policy. This allows them to get the guarantees and pay no further premiums.

However, for most people, the disadvantages of single premium life insurance, such as the high upfront cost and the modified endowment contract (MEC) tax implications, make it less appealing. You might be better off with a traditionally funded life insurance policy and investing in other vehicles like IRA accounts.

It’s always wise to seek guidance from a financial professional to determine the best strategy for your unique financial situation.

Frequently asked questions

• What is the best life insurance company?

  Choosing the best life insurance company is based on what is most important to you as a consumer and which carrier most closely matches your needs. Comparing insurance companies based on financial stability, the policies offered, policyholder reviews and family and friend recommendations is one way to determine which carrier provides the highest value. Consult with an insurance professional or your financial advisor to review coverage options and what product meets your financial goals.

• What insurance carriers offer single premium life insurance?

  Not all insurance carriers offer single premium life insurance as an option. The only way to confirm is to contact individual carriers. Some carriers will include this information on their websites and might even allow you to take part in an online quote process.

• How do I buy life insurance?

  Once you have selected which life insurance company you are most comfortable with and have selected the type of policy you need, it is time to purchase the policy. You will have to complete an application as the first step. Some carriers and policies will require you to answer a health questionnaire and take part in a medical exam, although some no-medical exam options exist. If you are approved, you will be required to sign paperwork and then make an initial payment for your policy to be activated.