Single premium life insurance (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. The size of the death benefit depends on the amount invested and the age and health of the insured.
Single-premium life insurance is fully funded from the get go, so the cash builds up quickly; but the amount of the death benefit varies based on how much was invested and the age and the health of the policyholder at the time the insurance was accrued.
Single Premium Life Insurance Explained
Single premium life insurance requires a large sum of money from the policyholder that puts this type of insurance out of reach of many applicants. The great advantage to single-premium life insurance is that the single payment fully funds the policy, immediately guaranteeing a sizable death benefit to the beneficiaries.
Another useful feature of some single-premium life insurance policies is their ability to finance long-term care, should the insured require it. Some single-premium life insurance policies allow policyholders to draw from the death benefit tax-free to pay living expenses. Such withdrawals decrease the amount of the death benefit accordingly.
Two popular single-premium policies are single-premium whole life and single-premium variable life. The two differ in how each policy accumulates a cash value. The first offers a risk-free fixed interest rate. The second invests the cash value in actively managed portfolios and comes with the risks and potential rewards of active investing.
A financial advisor may propose a single premium life insurance policy instead of a policy that requires annual premiums, typically to high-end clients. A single premium life policy also known as (SPL) is a pretty straightforward life insurance concept, but this type of policy has some nuances that are important.
It works like other whole life insurance policies, except that instead of paying an annual or monthly premium, the owner only needs to pay once in a lump sum single premium payment. This usually creates a modified endowment contract, meaning that tax treatment of pre-death withdrawals may be treated differently than other whole life insurance.
Single Premium Life Insurance Policies are Usually Modified Endowment Contracts
A modified endowment contract is what results when a life insurance policy gets “overfunded” in the first years of the policy. Because life insurance enjoys some favorable tax benefits such as potentially tax free withdrawals (up to the amount of premium paid), and dividend payments that are generally classified as tax free because they are considered to be a return of premium, the IRS wants to limit the extent to which people can take advantage of this favorable treatment. By putting a lot of money into a policy within the first 7 years (the test of whether a policy is a MEC is called a TAMRA 7 pay test), owners essentially turn a life insurance policy into an annuity with insurance protection.
The downside of a single premium life policy is that owners need to be aware of the consequences of owning a modified endowment contract. It is generally more tax efficient not to take surrenders before age 59.5 in order to avoid a 10% tax penalty and to keep dividend payments inside the policy by purchasing more paid-up life insurance. Owners can take money out as a loan, but they need to be aware that interest is charged while the money is outstanding and the death benefit is reduced by the amount of the outstanding loan.
An SPL is Dividend Eligible if Whole Life
A single premium life policy dividend eligible, also known as a “participating policy“. Every year when the life insurance company calculates it’s profits it returns a portion of those profits as dividends to whole life insurance policy owners. The dividends can be used to purchase additional paid-up insurance, pay premiums (not necessary with an SPL), or be taken as a payment. Beware, as mentioned above, if you take dividend payments they may be taxable if your policy is considered a modified endowment contract to the extent that there is a gain in the policy. They may not be taxable in the first few years, depending upon your cash value, the total premium paid, and the total dividend payments. Your advisor can calculate if and when your dividends are taxable and if they are subject to any tax penalties.
The Policy is Fully Funded on Day 1
When you purchase and fund an SPL policy, you don’t need to put any more money in unless you take policy loans. The policy is considered “fully funded”. This does not mean that the cash value is equal to the death benefit, because it is not. It also doesn’t mean that your cash value will be as high as the amount of premium you paid, because at first it will be lower. As a simple example, you might pay $10,000 in premium on day 1. Your premium payment for the coming year will be taken out of the policy, so you may have a cash value of $9,500. Your surrender value will further be reduced because by any surrender charges that are applicable, depending upon your policy year and surrender charge schedule. So while your cash value is a hypothetical $9,500, your surrender value may be 10% lower, or $8,550. As time goes on, your cash value will grow and will eventually be equivalent to your death benefit as does any policy at maturity. Surrender charges also reduce to 0 over 5-12 years so your cash value will become closer to your surrender value until eventually they are the same.
High Minimum Payment
Most single premium policies have a high minimum. Usually, a client must make a payment of at least $5,000 to $10,000, depending upon the issuing company, to meet the minimum requirement for SPL. The exact minimum depends upon the rules of the insurance company and specific product, and generally, minimums go up every few years. It is important to note this if you are planning on purchasing a single premium life insurance product because not everyone can reasonably afford to make the upfront investment.
The benefits for an SPL policy are generally the same as other whole life insurance products. Riders either are included or can be added for a fee such as the disability income rider, long-term care riders either providing cash or the ability to take withdrawals prior to death free of taxes, or accelerated death benefit that allows payouts prior to death in the event of a terminal illness.
As an Investment
Some people may choose an SPL policy because the return on investment for cash value growth and dividend payments may project to be higher than a standard whole life policy. In other words, it may have a higher rate of return. Because people do use life insurance as an investment, this is potentially a huge benefit for the owner while they are alive. An SPL policy should have a positive rate of return as soon or possibly even prior to the surrender charge schedule finishing.
Why Buy a Single Premium Life Policy
There are two big reasons to buy a whole life SPL policy. The first is that you only need to make one payment for the whole lifetime of the policy, so you don’t need to worry about adding funds or making payments. The second and most important is that the rate of return is usually higher than a traditional whole life policy with the same insurance coverage.
The reason that someone would purchase a single premium variable universal life policy is that the rate of return is possibly even higher if the market performs well, but the risk is that there will be no cash value if the market performs poorly. For this reason, we advise clients to use whole life SPL policies and use an investment account if they want exposure to the stock market.
Who Might Need Single Premium Life Insurance?
Single premium life insurance may be a good option for life insurance buyers with certain situations such as:
- When guarantees are important. Single premium life insurance policies feature guaranteed cash values and death benefits. Insurance companies may credit additional interest or dividends.
- If you have a special needs child. The death benefit can be used to fund a special needs trust to provide lifetime income for a child or other dependent.
- For estate planning. A single premium life insurance policy can be helpful when heirs may face an estate tax and the policy owner would benefit by transferring assets out of their estate. This should only be done in consultation with a qualified estate planning attorney.
- When replacing an existing life insurance policy. A single premium life insurance policy can be funded through an IRS section 1035 tax free exchange of the cash value from an existing life insurance policy. This is helpful when the policy owner does not wish to make further premium payments but wants to keep a life insurance policy in-force.
Who Should Not Buy Single Premium Life Insurance?
Here are some reasons why you would not purchase single premium life insurance:
- High premium. The minimum single premium is usually at least $5,000. If you need a large life insurance policy, your single premium payment will be significant.
- Pre-paying premiums. If you die earlier than expected, you could have paid substantially less in annual premiums if you had opted for regular premium payments.
- No additional contributions allowed. You cannot pay additional premiums to the policy.
- Limited access to cash value if you change your mind about the policy. Life insurance policies typically have surrender charges for the first few years.
- Early withdrawal penalties. Single premium life insurance policies are usually classified as a modified endowment contract (MEC). An MEC has a 10% income tax penalty on withdrawals above cost basis prior to age 59 1/2. This income tax penalty also applies to policy loans.
Is Single Premium Life Insurance a Good Investment?
Single premium life insurance is not an investment, it is an insurance policy that has a cash value. This is an important distinction, as the policies are not designed primarily as an investment vehicle.
Life insurance is often sold as an investment by agents and financial advisors. While permanent life insurance policies do accumulate a cash value, the cash value is simply a feature of the policy.
Life insurance is often promoted as an investment because the cash value grows on a tax-deferred basis. It’s important to note that this tax-deferred growth is based upon current tax law and might be changed in the future. Congress has discussed revoking the tax deferred status of life insurance policies on more than one occasion.