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.
Only One Premium Payment is Allowed
Perhaps the most pertinent feature of the single premium policy is that the policy only takes one premium payment, and it is funded for life. What some people may not realize is that even if the owner wants to pay an additional premium into the policy, they are not allowed once the policy is open. One and only one payment is ever made.
Two Options for Single Premium Policy Types
Far and away the most popular single premium product is the single premium whole life policy. Alternatively, some companies offer a single premium variable universal life policy. Generally speaking, we do not recommend a single premium variable universal life product to our clients because they generally have little advantage over a standard variable universal life policy that is correctly funded. The one big advantage is that the policy is guaranteed to stay in force even if the investments drop significantly and the policy runs out of cash, but it potentially offers higher upside for cash value growth.
When it comes to single premium variable universal life products, because the policy is guaranteed to stay “in-force”, insurance companies generally restrict your choices for asset allocation. Usually, either certain standards for bond/equity allocations must be met, or a highly restrictive list of investment options exist that must meet the companies standards for risk and upside. Basically, the insurance company doesn’t want people choosing risky speculative investments inside of their SPVUL policy because they have protection if the value drops.
This is a “Cash Value” Type of Life Insurance
The policy is not like term life, which has no value upon surrender and no options for the policy owner to take loans or withdrawals against the value. See this for a larger explanation of the difference between a whole life policy and a term policy. An SPL policy is similar to a whole life or universal life policy in that it is cash value form of insurance. The policy itself has value, and that value can be accessed by the owner at any time with loans or partial surrenders. It is considered an asset on a personal balance sheet.
The cash value of this type of policy is relatively high from the day the premium payment is made because instead of premiums paid over time there is one large payment. The cash value continues to grow over time and will accumulate until it becomes equal to the death benefit at the policy age of maturity. Loans and withdrawals will, of course, reduce the cash value.
Single Premium Life 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.
If you are interested in purchasing a single premium life policy you can contact your advisor, or get an SPL policy quote here.