Capuski / Getty Images This article reviews the essentials of single-premium life insurance: how it works, pros and cons, and alternatives to consider.
Definition of Single-Premium Life Insurance
Single-premium life insurance is insurance coverage designed to require only one premium payment. That payment funds the cash value of a permanent life insurance policy and ideally covers the insurance costs for the rest of your life.
Acronym: SPL
How Single-Premium Life Insurance Works
Single-premium life insurance allows you to make a substantial payment into a life insurance policy to provide a tax-free death benefit to your beneficiaries. This type of insurance is not ideal for most young families who want to protect against the death of one parent, as it requires a substantial lump-sum payment to get any meaningful death benefit. But wealthy people might consider a single-premium policy—along with several alternatives—as a wealth-transfer strategy.
Tax Issues
Like other permanent life insurance policies, a single-premium life insurance policy has a cash-value account you can withdraw from or borrow against. However, paying for lifetime insurance coverage with a single premium often results in the IRS treating your policy as a modified endowment contract (MEC), which doesn’t enjoy the same tax advantages as regular life insurance contracts. A MEC is a policy you pay into at a rate that exceeds IRS limits. When a policy fails the “7-pay test,” any loans and withdrawals are typically taxable to the extent you have any gains, making it less attractive to use the cash value in your policy. And in many cases, if you’re under age 59 ½, you’ll also face a 10% penalty on early withdrawals.
Example
If you have extra funds that you plan to leave to heirs or charity, one option is to purchase a single-premium policy. For example, a 67-year-old non-smoking woman with a spare $100,000 might be able to purchase a permanent life insurance policy with a death benefit of $169,660. At death, her beneficiaries would be able to claim the death benefit—typically without any income tax due. Before deciding on any single-premium strategy, review your situation with your CPA.
Accelerated Death Benefit
Although a single-premium policy is primarily designed for the death benefit, you might have access to an accelerated death benefit (ADB). With an ADB and a qualifying health condition, such as a terminal illness, you can potentially access a portion of the death benefit “early” to pay for health care, long-term care, and other needs—and you may be able to use those funds without tax consequences. If you use an ADB to tap your death benefit early, your beneficiaries will receive a reduced death benefit after you die.
Types of SPL Insurance
Single-premium policies are available in several flavors. Your choice affects what happens with the cash value inside the policy.
Whole life insurance has a set premium schedule and minimum interest rate that are defined at policy issue.Universal life policies feature interest earnings and insurance costs that may be less predictable than whole life policies.Variable life insurance offers investment options similar to mutual funds, but you may have to make extra premium payments (or risk losing coverage) if the investments don’t perform well.
Pros and Cons of Single-Premium Life Insurance
Pros Explained
Single Premium Payment
When you only have to pay one premium for lifelong coverage, the policy is easy to manage. That’s helpful when policy owners age and experience cognitive declines or other issues that take priority over financial matters. However, in some cases, even so-called single-premium strategies require additional premium payments, so somebody needs to pay attention to the policy.
Early Access to Death Benefit
Single-premium strategies can help you transfer assets to others efficiently. But if you end up needing the money yourself, you may be able to access it with an ADB rider. That early access can help you pay for long-term care, a final vacation with loved ones, or other end-of-life expenses.
Beneficiaries Receive a Tax-Free Death Benefit
A death benefit is generally a favorable way for heirs to receive funds. The money is typically free of income tax, and the funds do not need to go through an expensive or time-consuming probate process.
Cons Explained
Substantial Assets Needed To Pay a Large Premium
Although minimum premiums might start at $10,000, at that level, the death benefit is probably not large enough to support a young family after losing a wage-earning parent. Accessing a death benefit large enough for your family’s needs might require a significantly higher upfront payment.
Restrictions on Accessing Cash Value
Because single-premium policies are often considered MECs, it’s hard to use the cash value during your life. If you do, it’s likely that you’ll owe income taxes, and other tax issues may arise. Also, borrowing against a policy or taking withdrawals can reduce the death benefit or result in a loss of coverage.
Other Strategies Might Be More Appropriate
The simplicity of a single-premium policy may sound intriguing, but in many cases, other strategies (that don’t charge insurance premiums) are a better fit. These might include investing in assets that are accessible to you and could appreciate to be worth more than a life insurance policy.
Alternatives to Single-Premium Policies
Depending on your needs, there may be several solutions available. Explore your options with input from a tax expert and your financial planner before you move forward with any strategy.
Term Life Insurance
For families protecting themselves against the death of a wage-earning parent, an inexpensive term insurance policy is often a good solution. With that approach, you pay smaller monthly or annual premiums, and coverage only lasts for a set number of years. When you don’t need permanent insurance, term insurance might be an appropriate alternative.
Other Permanent Policies
You can get permanent coverage with several other types of life insurance. Whether you pay every month, every year, or for a limited number of years, you can often customize your coverage to fit your needs—and potentially avoid the tax pitfalls of a single-premium approach.
Investment Alternatives
If your primary goal is to maximize the amount you’ll pass on to heirs or charity, you might not need an insurance policy. Some accounts allow you to name a beneficiary or use a transfer on death registration that enables your heirs to avoid probate. If your assets qualify for a step-up in cost basis at death, the transfer is also tax-friendly. Most families don’t need to worry about estate taxes, so it’s worth evaluating whether or not insurance is necessary.
