Life insurance policies typically have ongoing, regular premium payments. Single premium life insurance policies are specifically designed to be funded by one single premium payment. You may be attracted to the features and benefits of single premium life insurance.
Almost any universal life, variable universal life or indexed universal life insurance policy can be funded with a single premium, even if it’s not officially sold as a “single premium life insurance” policy.
But other policies are sold specifically with one premium payment. These single premium life insurance policies provide a guaranteed death benefit for a set period of years or age, depending on the policy.
What Are Single Premium Life Insurance Options?
There are single premium products available for all types of permanent cash value life insurance:
- Whole life insurance. The policy has a guaranteed dividend schedule. The insurance company may credit additional dividends to you, at its discretion.
- Universal life insurance. Universal life insurance has a guaranteed interest rate. The insurance company might also credit a higher interest rate.
- Variable life insurance. There is no guaranteed earnings rate. The cash value is allocated to specific investments, called sub-accounts. You can choose a fixed account which has a fixed earnings rate for a portion, or all of your cash value.
- Indexed life insurance. There is no guaranteed earnings rate. The cash value is allocated to specific indexed accounts. You can choose a fixed account that has a fixed earnings rate for a portion, or all of your cash value.
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.
Other Cautions When Buying Life Insurance
Life insurance policies have a lack of transparency. They consist of three general components: earnings, cost of insurance and expense charges. These charges are not always disclosed and they can be changed by the company at will.
Life insurance companies also typically do not disclose when they’ve made a change to mortality costs or expense charges. You won’t know the overhead expenses.
Any excess earnings rate, above your guaranteed rate, on a whole life insurance policy or universal life insurance is at the discretion of the insurance company. Life insurance companies do not disclose how they determine their dividend payout rate or their credited interest rate.
All that said, single premium life insurance can be a useful financial planning tool for specific situations. Most people will be better off with a life insurance policy that provides more flexibility.
This article originally appeared on Forbes Advisor (here).