Single premium life insurance

A single premium life insurance policy falls under the umbrella of life insurance, which is a broad term with many coverage options. A single premium policy is one in which the premium is paid in one lump sum. In turn, the death benefit of a life insurance policy is guaranteed to be paid out in most cases. However, before you pay a large lump sum for life insurance, you must first understand the benefits and limitations of single premium life insurance.

What is single premium life insurance?

A single premium life insurance policy (SPL) is one that is funded with a single lump sum payment. When the policyholder dies, the policy pays out a tax-free death benefit. Most life insurance policies, including whole and term life, require a monthly or annual premium to be paid over a set period of time.

Premiums for term life insurance must be paid on a monthly, quarterly, semi-annual, or annual basis for a specified term length, which is typically 10, 20, or 30 years. The death benefit is no longer active once the term has expired. Whole life insurance has the same payment options as term life insurance, but the death benefit is guaranteed to be paid in most cases as long as the premiums are paid on time. Keep in mind that even whole life insurance policies may contain clauses stating that the death benefit will not be paid in certain circumstances, such as suicide.

A single premium option is available in three forms: single premium whole life insurance, universal life insurance, and variable life insurance.

• Single premium whole life. This falls under the umbrella of whole life insurance, which is a type of permanent life insurance. With single premium whole life insurance, you pay a lump sum for a policy that accumulates cash value over time and earns a set amount of interest.
• Universal life. A universal life insurance policy is similar to whole life insurance in that the cash value of the policy is guaranteed to grow. The distinction is that universal policies are more flexible and accumulate cash value in a different manner than whole life insurance.
• Variable life insurance. A variable life insurance policy also accumulates cash value, but at a variable rate. You have few options for investing, such as mutual funds, but your policy can outperform or underperform the market.

Modified endowment contract

A modified endowment contract (MEC) is a type of cash value life insurance that has exceeded the legal tax limits. The IRS considers a life insurance policy to be a modified endowment contract when the premium payments have overfunded the policy. According to the IRS, the policy must meet three criteria in order to be classified as a MEC:

• The policy was bought on or after June 20, 1988.
• The MEC qualifies as a life insurance policy.
• The policy fails the "seven-pay" test, which compares the total premiums paid in the first seven years of the policy to the total amount required to pay off the policy in full.

A single premium life insurance policy would fail the seven-pay test because it is paid in one lump sum and is fully paid up. A single premium life insurance policy is a MEC, which means that when money is withdrawn from the policy's cash value, it is subject to certain tax implications.

Pros and cons of single premium life insurance

Because there are numerous life insurance options available and a single premium life policy requires a significant upfront investment, you should be aware of both the advantages and disadvantages of choosing this policy.

Pros of single premium life insurance

• Guaranteed cash value and death benefits in most circumstances.  Because the premium is paid in advance, the policy is guaranteed to build value and to be paid out in most circumstances.
• Single payment. Instead of budgeting for premium payments at various points, you can make one lump sum payment.
• Can borrow from the policy. You may be able to borrow against the cash value of your policy to pay for expenses such as long-term care insurance. Keep in mind that the IRS considers single premium life insurance to be a MEC, so this will have tax implications.
• Could be valuable for estate planning. A single premium life insurance policy could be an important part of your estate planning. An estate planning attorney would be able to advise you on how to best use the policy.

If you are financially secure and want your life insurance policy to be fully paid for the benefit of your beneficiaries, single premium life insurance may be an option worth considering. This method of obtaining life insurance also provides peace of mind due to the transparency of what to expect in terms of policy value and payout in the future.

Cons of single premium life insurance

• Lump sum payment. Some people may find it difficult to pay a lump sum premium up front.
• It is possible that you will overpay. If you die before you expected, your policy may not have enough time to gain additional value.
• Policy access is restricted. If you change your mind about keeping the life insurance policy, there are usually large surrender fees, especially if you do so within the first few years.
• Contributions are restricted: Once you've chosen the single premium option, you can't make any more contributions to the policy.

There are other options for obtaining life insurance if you do not have a nest egg to pay the SPL premium costs upfront. Furthermore, paying a large lump sum may keep you financially flexible for other estate planning issues, such as legal fees. Paying for your life insurance policy in installments may also be the best option for your beneficiaries, as it may allow you to afford more insurance coverage through a multiple-payment option. Policies with a multiple-premium payment option can still give your beneficiaries peace of mind about the financial security they can expect when the policy is paid out.