With a single premium life insurance policy, you pay for the entire policy up front in one payment. That payment guarantees the death benefit, and ensures your policy will never lapse. But there are other financial benefits and considerations, too – including tax implications.
Here’s what we’ll cover:
How Single Premium Policies Work
Tax Implications of Single Premium Life Insurance
Pros of Single Premium Policies
Cons of Single Premium Policies
Next Steps
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Request a Free QuoteHow Single Premium Policies Work
With most life insurance policies, you make payments on a regular basis: either monthly, semi-annually, or annually. You must keep making those payments to keep your policy active. Each payment gets split up to cover the various costs associated with a policy: the cost of your coverage, administrative costs and fees, and cash value (for cash value/permanent policies).
With single premium life insurance, the insurer gives you one payment amount that covers the lifetime cost of your coverage, administrative costs, and cash value all at once. Depending on how large a policy you want, that single payment could be in the six figures. Once you pay it, your policy is fully funded and the death benefit is guaranteed for your beneficiary(ies). Single premium policies are available for multiple types of permanent cash value coverage: whole life, universal life, or variable life.
Think of cash value as being similar to a savings account, attached to your policy. These accounts are funded by your premium payments as well as interest credited by your insurer. Since your policy is fully funded from the get-go, you have more principal in place which earns interest at a higher rate than a traditional policy. You can access that cash value via policy loans or partial withdrawals. However, single premium policies have extra restrictions on when you can access that money, and how much income tax you owe when you do access it. We’ll go over those next.
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Request a Free QuoteTax Implications of Single Premium Life Insurance
Prior to 1986, many investors used single premium policies as tax shelters. Back in the day, you could store as much cash as you wanted in your cash value life insurance policy, and take policy loans that were virtually interest-free. How? Because the interest rate on your policy loan was essentially cancelled out by the cash value interest paid by your insurer. Best of all, you didn’t have to pay income tax unless you withdrew more money than you’d paid into the policy; and if you took out a loan, you could borrow more money than you’d put into the policy with zero income tax obligation.
All that changed with the Technical and Miscellaneous Revenue Act of 1988.
Since people were treating their fully funded policies more like an investment than insurance, Congress changed the rules to treat these policies more like a traditional investment account, removing the tax breaks. In a nutshell, Congress changed the classification of all single premium life insurance policies to what’s called a “modified endowment contract” (MEC, pronounced “meck”). And the new rule for MECs stated that, with any policy loans or partial withdrawals of cash value, taxable gains would have to come out first before the principal. That means any policy loan or withdrawal would create an income tax obligation. That means there are essentially no tax breaks left.
But that’s not all.
Much like a 401(k) or non-qualified annuity account, you can be penalized for withdrawing money from a MEC if you do so before the age of 59 ½. If you do, you may have to pay the IRS a 10% penalty, in addition to the income tax you owe on the amount withdrawn. If you wait until after age 59 ½, you’d avoid the extra penalty, but would still owe income tax on the amount you withdrew.
➡️ Rather talk to a real person about the how life insurance can be used in retirement and estate planning? Call us at (800) 823-4852 or click the button below to request a single premium life insurance quote!
Request a Free QuotePros of Single Premium Life Insurance
Despite the tax implications, single premium policies can be valuable for the right clients.
- Your cash value interest rate is often higher than regular savings accounts. Some clients just need a place to park their cash and earn as much interest as possible. With a whole life policy, that rate is guaranteed and locked in when you buy your policy, an attractive feature when interest rates are high.
- Periodic cash value loans can be used as retirement income. If you’re over 59 ½, you’d no longer incur the extra 10% IRS penalty to withdraw cash value or take a policy loan. You would still owe income tax, but that cash could still be a valuable source of supplementary retirement income.
- Death benefit is income-tax-free. When you pass away and your beneficiaries file a claim, they’ll get the death benefit with zero income tax obligation. That makes it a smooth and easy way to pass wealth to the next generation, without the need for probate or other legal hassle.
➡️ Prefer to talk to a real person about the how life insurance can be used in retirement and estate planning? Call us at (800) 823-4852 or click the button below to request a single premium life insurance quote!
Request a Free QuoteCons of Single Premium Life Insurance
The bottom line? Single premium policies actually lose a lot of the benefits you can get with a traditional cash value policy.
- Could that money be used elsewhere? You have to consider your overall financial situation. For example, are there other investments you could be making that would generate more revenue? Would you rather have liquidity? Yes, you can take a policy loan or partial withdrawal to access the money you’ve put into your single premium policy, but both actions come with a cost: fees for a withdrawal, an interest rate on the loan, plus the income tax implications. If the lump sum you need to fund the policy would take most or all of your cash, it’s probably not a good idea.
- You don’t need to fully fund a policy to guarantee a death benefit. With a term life policy or whole life policy, for example, that death benefit is guaranteed even if you’ve only made a year of payments. You don’t need to fully fund these policies to guarantee the death benefit. That’s the whole purpose of a life insurance contract – the insurer promises to pay the death benefit as long as you policy is active. If your primary motivation is to guarantee your loved ones get the death benefit when you pass away, it’s not necessary to use single premium life to ensure that happens.
- Tax implications. Both withdrawals and policy loans are taxed, which isn’t necessarily the case with a traditional (non-single-premium) policy. With a traditional policy, you can borrow or withdraw up to the amount you’ve paid into the policy before triggering income tax obligations.
- Possible IRS early withdrawal penalty. If you withdraw or borrow funds before age 59 ½, you may owe an extra 10% to the IRS. With a traditional policy, you can withdraw or borrow funds at any age without the potential for an IRS penalty.
➡️ Prefer to talk to a real person about the how life insurance can be used in retirement and estate planning? Call us at (800) 823-4852 or click the button below to request a single premium life insurance quote!
Request a Free QuoteNext Steps
If you’re looking for ways to maximize retirement income or use life insurance in estate planning, we can help!
Our licensed life insurance advisors have experience helping clients protect their loved ones and ensuring as much wealth as possible transfers to the next generation. Tell us about what you’re looking to achieve, your financial goals, and we’ll help craft an insurance plan that protects and grows your wealth for this generation and the next.
➡️ Call us at (800) 823-4852 or click the button below to request a single premium life insurance quote!
Request a Free QuoteAlways consult your accounting, legal, and tax advisors before implementing any recommendations. This material does not constitute tax, legal, or accounting advice. It cannot be used for the purpose of avoiding any IRS penalty.