The main benefit of life insurance is to create an estate that can provide for survivors or leave something to charity. Single-premium life (SPL) is a type of insurance in which a lump sum of money is paid into the policy in return for a death benefit that is guaranteed until you die. Here we look at some of the different versions of SPL available, offering a wide range of investment options and withdrawal provisions.
With single-premium life insurance, the cash invested builds up quickly because the policy is fully funded. The size of the death benefit depends on the amount invested and the age and health of the insured. From the insurance company's perspective, a younger person is calculated to have a longer remaining life expectancy, giving the funds paid in the premium more time to grow before the death benefit is expected to be paid out. And, naturally, the larger the amount of capital you initially contribute to your policy, the greater your death benefit will be as well. For example, a 60-year-old female might use a $25,000 single premium to provide a $50,000 income-tax free death benefit to her beneficiaries, whereas a 50-year-old male's $100,000 single premium might result in a $400,000 death benefit.
Living Benefits of Single-Premium Life Insurance
While the death benefits of insurance policies provide you with an efficient means of providing for your dependents, you also need to consider unexpected needs that might arise before you die. You probably understand the importance of long-term care (LTC) insurance, as long-term care can often turn out to be an expensive predicament. But what if you can't bring yourself to pay the annual LTC premiums? SPLs can offer a solution.
Some SPL policies give you tax-free access to the death benefit to pay for long-term care expenses. This feature can help protect your other assets from the potentially overwhelming cost of long-term care. The death benefit remaining in the policy when you die will pass income-tax free to your beneficiaries. And if you don't use any of it, the money will go to your loved ones just as you had originally planned. Therefore, your SPL plan allows you to cover your long-term care needs as required, but still leaves the maximum possible amount of your death benefit intact for your dependents. (For related reading, see: Long-Term Care Insurance: Who Needs It?)
A number of SPL plans also allow you to withdraw part of the death benefit if you are diagnosed with a terminal illness and have a life expectancy of 12 months or less. This flexibility can make the decision to pay a large single premium less daunting, and it is important to consider if you have limited financial assets outside of your SPL.
Investment Options With SPL Policies
There are two popular single-premium policies that offer different investment options:
- Single-premium whole life pays a fixed interest rate based on the insurance company's investment experience and current economic conditions.
- Single-premium variable life allows policy owners to select from a menu of professionally managed stock, bond and money market sub-accounts, as well as a fixed account.
Your choice should depend on your ability to handle market changes, the makeup of the other assets in your portfolio, and how you plan to use the policy's cash value. With a fixed interest rate, you can depend on the safety and stability of the constant growth rate in your policy, but you miss out on potential gains if the financial markets have a good run. The minimum death benefit is established when you purchase the policy, but if the policy's account value grows beyond a certain amount, then the death benefit can go up as well.
On the other hand, if you are willing to risk underperformance for a chance for greater returns, a variable life insurance policy with sub-accounts invested in equities and bonds may make more sense for you.
SPL policies give you control over your investment, allowing access to the cash value for emergencies, retirement or other opportunities. One way to tap into the cash in the policy is with a loan. You can generally take a loan equal to 90% of the policy's cash surrender value. This will, of course, reduce the policy's cash surrender value and death benefit, but you have the option to repay the loan and re-establish the benefit.
Companies will also let you withdraw funds and deduct the withdrawal from the policy's cash surrender value. They usually have a minimum amount you can remove. The amount you can take out each year without paying a surrender charge might be 10% of the premium paid in or 100% of the policy's gains, whichever is greater.
However, an extra cost can arise from withdrawals or loans from your SPL, since SPL policies are usually considered modified endowment contracts. This means there is a 10% IRS penalty on all gains withdrawn or borrowed before age 59.5. You will also have to pay income tax on those profits. Plus if you cash in the policy, the insurance company might hit you with a surrender charge. (For related reading, see: Avoiding the Modified Endowment Contract Trap.)
Investment Grows Tax-Deferred
Your investments will grow tax-deferred inside the policy. As noted above, you will pay tax on the earnings if you withdraw or borrow from the policy, but your named beneficiaries will receive the benefits income-tax free and without the time delay and expense of probate. This is an important benefit, as you do not want the effort and expense you devoted to providing death benefits for your dependents to be muted by undue time delays and probate costs.
SPL Has Drawbacks
The minimum amount you can invest in an SPL policy is generally $5,000, which can make it cost-prohibitive for many investors. Additions are not allowed. You should only consider using funds you had intended to pass on to the next generation or to help fund a long-term goal, such as retirement. Also, you will have to meet the insurance company's medical underwriting standards to qualify for SPL.
The Bottom Line
If you have cash you don't need right now and you want guaranteed life insurance protection for your family or your favorite charity, single-premium life insurance may be the ideal product for you. It is also an excellent way to begin a child's life insurance program.
For instance, you could specify a child or grandchild as the insured and keep the policy in your name. That way you would still have control over the cash value. Or you could make him or her owner as a way to remove the policy from your estate. However you choose to use a single-premium life insurance policy, remember to consider your personal financial situation and other retirement vehicles already in use so you can select and shape your policy to best match your needs. (For related reading, see: Types of Whole Life Policies.)