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Single premium life insurance (SPL) is a type of policy that can be fully funded in a single payment. In return, you would receive a death benefit that is guaranteed until you die. A single premium policy is a form of permanent life insurance with a cash value that grows over time and can be borrowed against.
Due to the large premium payment, all single premium policies are considered modified endowment contracts (MEC), which have their own tax characteristics.
What Is Single Premium Life Insurance (SPL)?
Single premium life insurance is a form of life insurance that's paid with one upfront lump-sum premium. Once you've purchased a single premium policy, you would receive a permanent death benefit that extends until you die. This differs from other life policies, such as whole life insurance, where premiums can be paid on a monthly or annual basis. It also differs from term life insurance in that coverage is permanent, whereas a term policy only extends coverage for a set period of time, such as 20 years. For example, a term policy could have annual premiums of $500 for the entire length of the policy. On the other hand, a single premium policy could have one $25,000 premium at the start and no additional payments for the rest of the policy life.
The size of the death benefit of a single premium life insurance policy will depend on the amount of money initially invested and the age and health of the insured. For example, a 30-year-old in good health could invest $50,000 in a single premium life insurance product and receive a death benefit of $250,000. On the other hand, a 60-year-old with similar health could invest $50,000 and may instead receive a death benefit of $125,000.
Depending on your coverage needs, you can purchase a single premium whole life, universal life or variable life insurance policy.
Single Premium Whole Life (SPWL)
Single premium whole life insurance is a subcategory of SPL. Whole life is a form of permanent life insurance, which builds cash value over the life of the policy. The cash value of the policy grows at a guaranteed interest rate over time.
Single Premium Variable Life
Single premium variable life insurance differs from standard single premium coverage in that the policy's cash value grows at a variable rate, depending on how you choose to invest it. Your options are limited by those offered by your insurer, but they're typically similar to mutual funds in that they can track:
- An index (such as the S&P 500)
- An equity portfolio
- A money market fund
- A bond portfolio
In a single premium variable life insurance policy, you will not be actively managing the investments. And there are fees associated with single premium variable life insurance, which can vary depending on the investment products you select. Variable life can be a great policy if your chosen investments outperform the expected growth of a lower-risk product, such as whole life insurance, but this is not guaranteed. This, combined with the fees from the management of the investment, can reduce the cash value in the policy.
Single Premium Universal Life
Single premium universal life is similar to the whole life insurance but it provides coverage until you reach a certain age instead of a certain period of years. This makes universal life a form of permanent insurance, which can be set up to span your lifetime. Furthermore, it is similar to whole life in that the policy has a minimum guaranteed cash value growth rate. But the guaranteed rate is lower, and your actual cash value growth rate can differ depending on the investment performance. With these policies, you're offered multiple options, similar to variable life.
What Is a Modified Endowment Contract?
A modified endowment contract (MEC) is a life insurance policy with a different tax structure. A policy becomes a modified endowment contract when premium payments have exceeded a certain limit and the policy is considered overfunded. Some characteristics of a MEC include:
- The policy..
- Is entered into after June 20, 1988
- Is a registered life insurance policy
- Fails the 7-pay test
The 7-pay test is an assessment that calculates the level annual premium required for a life insurance policy to be paid up in a seven year period. A policy fails the test if the premiums paid into the policy exceed the total amount needed to fully pay the policy, so no other premiums would be required for lifelong coverage.
For example, a universal life insurance policy could have a MEC maximum of $5,000 in annual premium payments every year for the first seven years of the policy. Say you were to pay $6,000 of premiums in one of the seven years, then the policy would exceed the maximum annual premium amount and would be considered a MEC.
In the case of single premium life insurance, since all premiums for the life of the policy are paid immediately, the policy would be considered fully paid up and fail the 7-pay test. Therefore, all single premium life insurance policies are considered modified endowment contracts.
Once an insurance policy is classified as a MEC, it cannot be reversed and can be subject to a withdrawal penalty. If you want to take out money or borrow from the policy's cash value before the age of 59 ½, you will incur a 10% tax penalty along with income taxes on that withdrawal. Furthermore, the withdrawal would happen on a last-in, first-out basis (LIFO) instead of first-in, first-out (FIFO) like other forms of permanent life insurance. This means any distributions would come from the interest gained on the cash value and would be subject to regular income tax.
For example, say you're 50 years old and wanted to withdraw $10,000 from the cash value of your single premium whole life policy. Since you are younger than 59 ½, you would have to pay 10% of the amount withdrawn to the IRS. In this example, that would be $1,000, which would go straight to the IRS and reduce the amount withdrawn to $9,000. Assuming you're taxed at 22%, your taxes owed would be $1,980. So you would actually receive $7,020 from the original withdrawal of $10,000 from your whole life policy.
Pros and Cons of Single Premium Life Insurance
Single premium life has benefits and downsides that must be considered before deciding if this is the right policy for you.
Single Premium Payment
If you'd rather pay for insurance upfront and avoid having to budget for monthly or annual premiums in the future, then a single premium payment structure could be valuable to you. Because a single premium policy is permanent life insurance it also negates the risk of you losing coverage later in life due to not being able to make premium payments, which could default the insurance policy. Overall, single premium life insurance allows you to have a hands-free approach to managing the policy.
Policy Loans and Living Benefits
A useful feature of single premium life insurance is the living benefits, which can fund a variety of expenses such as long-term care. Long-term care insurance can be expensive due to the high premium costs associated with the policy. Instead of LTC insurance, single premium life policies will allow the policyholder to borrow against the death benefit tax-free to make payments for long-term care. In this case, you would be taking out a loan and the value of the policy would be used 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 payments from the death benefit tax-free. Then, once you die, the death benefit left over in the policy will continue on tax-free to your selected beneficiaries. In both of these cases, single premium life policies give you the flexibility to be prepared for many different future events.
Growth of Cash Value
Cash value in single premium life insurance grows tax-deferred and can grow at different rates depending on if you choose whole, variable or universal life. A SPL policy's cash value also will grow more quickly than other permanent and term life insurance, due to the fact that it is fully funded from the start of coverage.
For example, with a single premium whole life policy, the initial premium could be $50,000. Some of this amount will go to fees, and other money goes directly to the policy's cash value. Assuming the cash value is $40,000 and you were guaranteed a 3.5% interest rate, the policy would grow by $1,400 after a year. On the other hand, say you had a standard whole life policy with an initial premium of $5,000 per year. Assuming after this premium you had $4,000 in the policy's cash value and were guaranteed a 3.5% interest rate, the policy would only grow by $140 after a year. This difference in growth is due to the size of the initial premium in single premium life insurance.
Downsides of Single Premium Life
One downside of single premium life is that the policy is considered a modified endowment contract. As we reviewed before, a MEC comes with added issues like the tax penalty for withdrawals or taking out loans from the policy. For those reasons, using a single premium life policy in the short term for receiving cash would not make sense unless for emergency needs.
Single premium life insurance also has cost limitations. The policy requires a large sum of money paid upfront. Therefore, unless you have a large amount of cash on hand, it will be difficult to get a policy with a sizable death benefit, and it may be insufficient if you're 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 with that amount, there still will not be much coverage. We recommend purchasing a policy that you can afford and gives you enough coverage so you do not need another policy in the future.
Is Single Premium Life Insurance Right for You?
SPL policies are a good consideration if you have enough savings to afford the large premium payment and are looking for guaranteed coverage throughout your lifetime. Furthermore, single premium policies are better than standard policies if you want to maximize cash value growth, so you can access it as a senior. By investing it into a product like SPWL insurance, you will be locking in a guaranteed fixed rate at which that cash value will grow. Since your policy's initial cash value is larger than it would be with a traditional whole life policy, it will accumulate at a faster rate. Once you're over the age of 59 ½ and can access the cash value without tax penalties, that money can be used to fund any expenses, such as medical care or sending a grandchild to college.
But, if you choose a variable or universal life policy, the investment options can also work against your favor. As we mentioned above, single premium variable life policy's cash value could decrease in value, depending on how it's invested. It is important to evaluate your individual risk profile and coverage needs when choosing a policy.
Single premium life insurance is offered through online quotes at several carriers. This includes companies such as State Farm and New York Life. But, these are not the only insurers that offer single premium life insurance. If you are interested in SPL, we recommend talking to an insurance agent to see if it is available, as many insurance companies offer these policies but may not market them.