What Is Single Premium Life Insurance? The Pros and Cons
A single premium life insurance (SPL) policy is one that can be fully funded in a single payment. In exchange, you will receive a death benefit that will be guaranteed until you die. A single premium policy is a type of permanent life insurance that includes a cash value that grows over time and can be borrowed against.
All single premium policies are classified as modified endowment contracts (MECs) because of the large premium payment. MECs have their own tax characteristics.
What is single premium life insurance (SPL)?
A single premium life insurance policy is one that is paid for with a single upfront lump-sum premium. After purchasing a single premium policy, you will receive a permanent death benefit that will last until your death.
This differs from other types of life insurance, such as whole life insurance, where premiums can be paid monthly or annually. It also differs from term life insurance in that the coverage is permanent, whereas a term policy only provides coverage for a limited time, such as 20 years. A term policy, for example, could have annual premiums of $500 for the duration of the policy. A single premium policy, on the other hand, could have one $25,000 premium at the start and no additional payments for the rest of the policy's life.
The death benefit of a single premium life insurance policy is determined by the amount of money initially invested as well as the insured's age and health. A 30-year-old in good health, for example, could invest $50,000 in a single premium life insurance policy and receive a death benefit of $250,000. A 60-year-old in comparable health could, on the other hand, invest $50,000 and receive a death benefit of $125,000 instead.
You can buy a single premium whole life, universal life, or variable life insurance policy based on your coverage needs.
Single premium whole life (SPWL)
SPL stands for single premium whole life insurance. Whole life insurance is a type of permanent life insurance that accumulates cash value over the policy's term. Over time, the cash value of the policy grows at a guaranteed interest rate.
Single premium variable life
Single premium variable life insurance differs from standard single premium coverage in that the cash value of the policy grows at a variable rate depending on how you invest it. Your insurer's options are limited, but they're typically similar to mutual funds in that they can track:
- An index (such as Standard & Poor's 500 index)
- A stock portfolio
- A money market fund
- Investing in bonds
You will not be actively managing the investments in a single premium variable life insurance policy. Furthermore, there are fees associated with single premium variable life insurance, which vary depending on the investment products you choose. Variable life insurance can be a great policy if the investments you choose outperform the expected growth of a lower-risk product, such as whole life insurance, but this is not guaranteed. This, together with investment management fees, can reduce the cash value of the policy.
Single premium universal life
Single premium universal life insurance is similar to whole life insurance in that it provides coverage until you reach a certain age rather than a specific number of years. As a result, universal life is a type of permanent insurance that can be set up to last your entire life. Furthermore, the policy is similar to whole life in that it has a minimum guaranteed cash value growth rate. However, the guaranteed rate is lower, and your actual cash value growth rate will vary depending on the performance of your investments. These policies provide you with a variety of options, similar to variable life insurance.
What is a modified endowment contract?
A modified endowment contract (MEC) is a type of life insurance with a unique tax structure. When premium payments exceed a certain threshold and the policy is considered overfunded, the policy becomes a modified endowment contract. An MEC has the following characteristics:
- Contracts entered into after June 20, 1988
- Registered life insurance policy
- Fails the seven-pay test
A universal life insurance policy, for example, could have a MEC maximum of $5,000 in annual premium payments every year for the first seven years of the policy. Assume you pay $6,000 in premiums over one of the seven years. The policy would then exceed the maximum annual premium amount and be classified as a MEC.
Because all premiums for the life of the policy are paid immediately in the case of single premium life insurance, the policy is considered fully paid up and fails the seven-pay test. As a result, all single premium life insurance policies are modified endowment contracts.
Once classified as a MEC, an insurance policy cannot be reversed and may be subject to a withdrawal penalty. If you withdraw or borrow money from the policy's cash value before the age of 59 1/2, you will face a 10% tax penalty in addition to income taxes on that withdrawal. Furthermore, unlike other types of permanent life insurance, the withdrawal would take place on a last-in, first-out (LIFO) basis rather than first-in, first-out (FIFO). This means that any distributions would be made from the interest earned on the cash value and would be taxed as ordinary income.
Assume you are 50 years old and want to withdraw $10,000 from the cash value of your single premium whole life insurance policy. Because you are under the age of 59 1/2, you must pay the IRS 10% of the amount withdrawn. In this case, $1,000 would be sent directly to the IRS, reducing the amount withdrawn to $9,000. Your taxes would be $1,980 if you were taxed at a rate of 22%. As a result, you would receive $7,020 from the initial $10,000 withdrawal from your whole life policy.
Pros and cons of single premium life insurance
Single premium life insurance has advantages and disadvantages that must be considered before deciding if it is the right policy for you.
Pro: Single premium payment
If you'd prefer to pay for insurance up front rather than having to budget for monthly or annual premiums in the future, a single premium payment structure may be advantageous. Because a single premium policy is permanent life insurance, there is no risk of you losing coverage later in life due to inability to make premium payments, which could result in the insurance policy defaulting. Overall, single premium life insurance allows you to manage the policy with minimal effort.
Pro: Policy loans and living benefits
The living benefits, which can fund a variety of expenses such as long-term care, are a useful feature of single premium life insurance. Because of the high premium costs, long-term care insurance can be costly. However, single premium life insurance policies allow the policyholder to borrow against the death benefit tax-free in order to pay for long-term care. In this case, you would take out a loan and use the policy's value as collateral.
Similarly, if you are diagnosed with a terminal illness and given less than a year to live, some SPL policies will allow you to receive a lump sum or death benefit payments tax-free. Then, when you die, the death benefit remaining in the policy will continue to be tax-free for your chosen beneficiaries. In both of these cases, single premium life insurance policies give you the freedom to plan for a wide range of future events.
Pro: Growth of cash value
Cash value in single premium life insurance grows tax-deferred and at different rates depending on whether you choose whole, variable, or universal life insurance. Because it is fully funded from the start of coverage, an SPL policy will see faster cash value growth than other permanent and term life insurance policies.
The initial premium for a single premium whole life policy, for example, could be $50,000. Some of this money will be used to pay fees, while the rest will go directly to the cash value of the policy. Assuming a cash value of $40,000 and a guaranteed interest rate of 3.5 percent, the policy would grow by $1,400 after a year.
Assume, on the other hand, you had a standard whole life policy with a $5,000 annual premium. Assuming you had $4,000 in the policy's cash value after this premium and were guaranteed a 3.5 percent interest rate, the policy would only grow by $140 after a year. The size of the initial premium in single premium life insurance accounts for the difference in growth.
Downsides of single premium life
One disadvantage of single premium life insurance is that it is classified as a modified endowment contract. As previously discussed, a MEC includes additional issues such as a tax penalty for withdrawals or loans from the policy. For these reasons, except in an emergency, using a single premium life policy to receive cash in the short term makes no sense.
The cost of single premium life insurance is also limited. The policy necessitates a substantial upfront payment. As a result, unless you have a large sum of cash on hand, it will be difficult to obtain a policy with a substantial death benefit, and it may be insufficient if you are purchasing life insurance to cover a large financial obligation, such as a mortgage. Most insurance companies require a minimum investment of $5,000 for an SPL policy, and even then, the coverage is limited.
We recommend that you purchase a policy that you can afford and that provides enough coverage so that you do not need to purchase another policy in the future.
Is single premium life insurance right for you?
SPL policies are a good option if you have enough savings to cover the large premium payment and want guaranteed coverage for the rest of your life.
Furthermore, single premium policies outperform standard policies in terms of cash value growth, which you can access as a senior. When you reach the age of 59 1/2 and are able to access the cash value without incurring tax penalties, you can use it to fund any expense, such as medical care or sending a grandchild to college.
However, if you choose a variable or universal life insurance policy, the investment options may work against you. As previously stated, the cash value of a single premium variable life policy may decrease depending on how it is invested. When selecting a policy, it is critical to consider your personal risk profile and coverage requirements.
Several carriers provide single premium life insurance quotes online. Companies like State Farm and New York Life are examples of this. However, these are not the only insurers who provide single premium life insurance. We recommend speaking with an insurance agent if you are interested in SPL, as many insurance companies offer these policies but may not market them.