Single Premium Life Insurance
B.A. Risk Management
Life Insurance Agent
What is Single Premium Life Insurance?
Single premium life insurance, also referred to as paid-up life insurance, is a type of permanent life insurance which requires you to pay the entire premium amount up front. Once you do, the policy stays in force until your death.
A single premium policy, like all permanent policies, has two components.
- A guaranteed death benefit amount, which is paid out to your family when you pass away.
- A cash value component, which accrues interest and grows in value as long as the policy stays in force.
The only difference is that regular policies allow you to pay the premium on a monthly, quarterly, or yearly basis – depending on your convenience.
Single premium policies require you to make a one-time lump-sum payment, which funds the policy until your death.
Different Types of Single Premium Life Insurance
When it comes to single premium, you generally have three options to choose from – whole life, variable, and universal life insurance.
Single Premium Whole Life
- The death benefit amount is guaranteed by the insurer.
- The cash value account is set to grow in value at a fixed rate, which is decided by the insurer.
If you are risk-averse by nature, this might be the best choice for you, since the policy is guaranteed to build cash value at a predetermined rate, regardless of market conditions.
Single Premium Variable Life
- The death benefit amount is guaranteed by the insurer.
- The cash value account is set to grow in value at a variable rate, depending on the performance of the investment accounts.
The unique selling point of a variable life insurance policy is that you get to decide where your premium payments are invested.
Depending on your preference, you can choose to invest in a fixed account (which grows at a fixed rate) or a bond account, stock account, index account, or a money market account, all of which grow at a variable rate, depending on how the market performs.
The upside of a variable life insurance policy is that it can accumulate cash value rapidly under favorable market conditions. The downside is that it can also lose cash value when the market goes down. Moreover, the management fees associated with the investment accounts can be quite hefty in many cases.
Single Premium Universal Life
- The death benefit amount is guaranteed by the insurer.
- You are assured of a minimum rate of return by the insurer right at the start of the coverage period. So, the cash value of your policy is guaranteed to increase every year – irrespective of the insurance company’s performance or market conditions. At the same time, if the insurance company’s investment portfolio performs well, the cash value growth rate of your policy will be higher than the minimum guaranteed rate.
One of the major advantages of a universal life policy is that it is cheaper than a whole life or variable life policy.
The downside is that the policy tends to build cash value at a slower rate compared to a whole life or variable life policy, as the premiums are lower, which in turn means that the amount allocated towards the cash value account is also lower.
Advantages and Disadvantages of Single Premium Life Insurance
As is the case with all other types of life insurance, single premium too has its own advantages and disadvantages. Let us take a look at them now.
Advantages of Single Premium
Lifelong Coverage with a Single Payment
A single payment policy, true to its name, requires you to pay only once. The lump-sum payment you make fully funds the policy, which provides you with the coverage you need for the rest of your life – without requiring any additional charges or payments.
A regular permanent policy, in contrast, requires you to make monthly or yearly payments for the rest of your life.
You are covered only as long as the premiums are paid on time. If you stop paying the premiums for any reason – job loss, health problems, legal trouble, and so on – your policy could lapse.
Despite the fact that it requires you to pay a substantial amount of money up front, a single premium policy is actually cheaper than a regular policy in most cases.
If you are a 45-year old non-smoker who does not have any pre-existing conditions, a $500,000 single premium universal life policy is likely to cost you around $75,000.
A regular universal life policy, on the other hand, is likely to cost you around $3,350 per year. Now, assuming you live until the age of 80, you have to pay a total of $117,250 ($3,350 x 35) until your death.
In the example given above, you stand to save $42,250 ($117,250 – $75,000) by buying a single premium policy instead of a regular policy.
Single premium policies, like all permanent life policies, allow you to dip into the cash value – in the form of a withdrawal or a loan – as and when you need. You should, at the same time, remember that if the loan amount is not paid back, it will get deducted from your death benefit.
Apart from this, most single premium policies also have provisions for funding your long-term care and terminal illness treatment expenses.
If you become terminally ill or if you need long-term care as a result of an illness or disability, you can receive a portion of the death benefit amount – either as a lump sum or as a series of payments.
Cash Value Growth
This is, without a doubt, the biggest advantage of buying a single premium policy. With a regular permanent policy, the cash value growth rate is gradual, as only a portion of your premium payments are allocated to the cash value component.
With a single premium plan, the cash value growth rate is much higher, as a large amount is allocated to the cash value component right at the start of the policy’s term.
For instance, let us assume that you pay $5,000 per year for a whole life policy. If 60% of your premium is allocated to the policy’s cash value and if the interest rate set by your insurer is 3.5%, the cash value of your policy will grow by $105 every year.
Now, let us assume you buy a single premium plan for $50,000. If 60% of your premium is allocated to the cash value and if the interest rate set by the insurer is 3.5%, the cash value of your policy will grow by $1,050 every year.
This is one of the reasons why people who are in need of a reliable source of income in their post-retirement life tend to buy single premium policies.
If you buy a policy at the age of 40 and allow it to build cash value without making any withdrawals or taking any loans, you will have access to a substantial amount of money during your post-retirement years.
Legacy for Your Family
The potential for accelerated growth makes single premium life insurance an attractive choice for people who want to leave a tax-free legacy for their family.
If you buy a single premium policy at the age of 50 and allow it to accumulate cash value for the rest of your life, you can leave behind a substantial amount of money for your grandchildren.
The death benefit amount that your beneficiaries receive is not taxable. So, your grandchildren can use it to fund their higher education, to start a business, or any other purpose.
Disadvantages of Single Premium Life Insurance
The cost of a single premium plan might be prohibitively expensive for many people – especially for those from low and middle income households. It is not cheap life insurance.
For instance, if you are a 40-year old man who does not smoke and does not have any pre-existing conditions, a $100,000 single premium policy is likely to cost you around $16,000.
Needless to say, not many people can afford to pay that kind of money for a policy, especially when you consider the fact that nearly 60% of the people in the country have less than $1,000 in savings.
Even if you happen to have a few thousands saved up, you might not be able to buy the amount of life insurance coverage that you actually need, especially if you have financial obligations and family members who are dependent on your income.
For example, a $250,000 guaranteed universal life policy is likely to cost you $37,000 – assuming you are healthy enough to qualify for the ‘preferred best’ rate. If you have pre-existing conditions, the policy might cost you even more.
This is one of the reasons why many people are hesitant to buy a single premium policy, even if it is cheaper than a regular policy in the long term.
Modified Endowment Contract
One of the biggest downsides of a single premium policy is that it is technically not a life insurance policy at all. It is what the IRS calls a modified endowment contract (MEC).
A policy is considered an MEC if it does not pass the 7-pay test. Each policy has an MEC limit – the maximum amount of premium that you can pay in the first seven years.
If the amount of premium you pay in the first seven years exceeds the limit, your policy automatically becomes an MEC.
Let us say you buy a universal life policy, whose MEC limit is set at $5,000 per year. Based on the 7-pay formula, the maximum amount of premium you are allowed to pay in the first seven years is $35,000 ($5,000 x 7). If you pay more than that, it becomes an MEC.
With a single premium policy, you are required to make a lump-sum payment – which is sufficient to fund the policy for the rest of your life – up front. As a result, it fails the 7-pay test right at the outset, which makes it an MEC.
Now, you might be wondering as to how an MEC differs from a life insurance policy and why it matters. It matters because of the way an MEC is taxed.
One of the biggest benefits of a permanent policy is the tax benefits it offers. The cash value of your policy increases on a tax-deferred basis. You are only required to pay taxes when you withdraw the money, that too if the amount withdrawn is larger than the amount of premiums paid into the policy.
The dividends paid by the insurer – if any – are not taxed, as they generally come under the ‘return of premium’ category. The death benefit amount, needless to say, is not taxed either.
On the other hand, if your life insurance policy is classified as an MEC, you lose some of the tax benefits mentioned above. For example, if you make a withdrawal or get a loan against your policy’s cash value before you reach the age of 59½, you are required to pay a 10% penalty. In addition to that, you have to pay taxes on the amount you withdraw or borrow.
Let us assume that you are 55 years of age and want to withdraw a sum of $8,000 from your policy’s cash value.
In this case, you have to pay a 10% penalty, which is $800, and pay taxes on the remaining $7,200. Assuming you fall into the 22% tax bracket, you have to pay $1,584 in taxes. As a result, the amount of money you will actually receive is $5,616.
Should You Buy Single Premium Life Insurance?
You can determine if you should buy a single premium policy or not by asking yourself the following questions.
Can you afford it?
You should calculate the amount of life insurance coverage you need, get personalized quotes from various insurance providers, and then decide if you can afford to buy a single premium policy.
If you need any help in calculating the amount of coverage you need and in getting personalized quotes from insurers, the experts at noexam.com will be happy to help you.
Based on your financial situation, do you think it is possible for you to let the policy build cash value in an uninterrupted manner until you reach the age of 59½?
As mentioned above, any amount of money you withdraw or borrow from the cash value of your policy – before you reach the age of 59 ½ – will incur penalties and taxes. So, unless it is an emergency, you should avoid dipping into your policy’s cash value before you reach the stipulated age.
Once you turn 59 ½, you can withdraw or borrow against your policy’s cash value without having to pay any penalties. Moreover, if you are planning to leave a legacy for your grandchildren, you should avoid accessing the cash value for your own needs.
If you borrow against the cash value and pass away before paying it back, the amount you were supposed to repay (principal, interest payments, and penalties, if applicable) will be deducted from your policy’s death benefit, which in turn will reduce the amount of money your beneficiaries will receive.
How NoExam.com Can Help You
We have been in the life insurance industry for a long time and know the intricacies involved in buying life insurance coverage. We believe that no two individuals have the same life insurance needs.
The type and amount of life insurance coverage you need depends on your age, occupation, health condition, financial situation, the size of your family, and many other factors.
We can accurately assess your financial needs and determine how much coverage you actually need. In addition to that, we can get you customized quotes from the best-performing life insurance companies in the industry today and help you choose a plan which fits within your budget and is best suited for your needs.
If you are in need of life insurance coverage and wondering if a single premium policy might be the right choice for you, get in touch with us today. We can work with you and help you buy the right amount of coverage from the right insurer.
NoExam.com is not associated with any particular insurance company. The expert advice we give, the suggestions we offer, and the recommendations we make are not biased towards or against any particular type of life insurance policy or company.
So, you can rest assured that we have nothing but your best interests at heart.