Single premium life insurance
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Life insurance is a broad term with many options for coverage, and under this umbrella is a product called a single premium life insurance policy. Single premium refers to a policy where the premium is paid in one lump sum. In turn, the death benefit of a life insurance policy is guaranteed to be paid out when you die under most circumstances. But before you shell out a large lump sum for life insurance, it is critical to understand the benefits and limitations of single premium life insurance.
- A single premium life insurance policy is a life insurance policy with a single, upfront lump sum payment.
- A single premium life insurance policy has a guaranteed death benefit and is typically guaranteed to build cash value.
- Once you have paid your single premium, no additional contributions can be made to your policy.
What is single premium life insurance?
A single premium life insurance policy (SPL) is one funded by an upfront lump sum payment. The policy pays out a tax-free death benefit upon the death of the policyholder. Most life insurance policies, including whole and term life policies, require a monthly or annual premium to be paid over a specific period.
Term life insurance options require premiums to be paid on a monthly, quarterly, semi-annual or annual basis for a selected term length, typically 10-, 20- or 30-year periods. Once the term is over, the death benefit is no longer active. Whole life insurance options also have the same payment options as term, but the death benefit is guaranteed to be paid in most circumstances as long as the premiums have been maintained. Keep in mind that even a whole life insurance policy may have clauses that specify circumstances where the death benefit may not be paid, such as suicide.
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 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.
Modified endowment contract
A modified endowment contract (MEC) is actually a form of cash value life insurance, but one where the legal tax limits have been exceeded. A life insurance policy is deemed a modified endowment contract by the IRS when the premium payments have overfunded the policy. The IRS states the policy must meet three criteria to be considered an MEC:
- Policy was purchased on or after June 20, 1988.
- The MEC meets the definition of a life insurance policy.
- The policy fails the “seven-pay” test — a calculation used to compare the total premiums you paid in the first seven years of the policy with the total amount to pay the policy in full.
Because a single premium life insurance policy is paid in one lump sum and fully paid up, it would automatically fail the seven-pay test. A single premium life insurance policy is an MEC, which means that it is subject to certain tax implications when withdrawing money against the cash value of the policy.
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
- Guaranteed cash value and death benefits in most circumstances. The policy is guaranteed to build value and is guaranteed to be paid out in most circumstances since the premium is paid upfront.
- Single payment. Instead of budgeting for premium paid at different points, you have the convenience of one lump sum payment.
- Can borrow against the policy. Your policy may allow you to borrow against the cash value to pay for expenses such as long-term care insurance. Keep in mind that this will come with tax implications, since single premium life insurance is considered an MEC by the IRS.
- Could be valuable for estate planning. A single premium life insurance could be a valuable part of your estate planning process. An estate planning attorney would be able to advise how the policy could be used to maximum effect.
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
- Lump sum payment. A lump sum premium can be difficult for some people to pay upfront.
- Could end up overpaying. If you pass away sooner than expected then your policy may not have enough time to gain additional value.
- Limited access to policy. There are typically large surrender fees if you change your mind about maintaining the life insurance policy, especially within the first few years.
- Contributions are limited: No additional contributions can be made to the policy once you have selected the single premium option.
If you don’t have a nest egg on hand to pay the SPL premium costs up front, there are other options for obtaining life insurance. Additionally, paying a large lump sum may keep you financially flexible for other areas of estate planning that need to be addressed such as legal fees. 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 your beneficiaries peace of mind with what to expect in terms of financial security when the policy is paid out.
Frequently asked questions
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.
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.
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.