Single premium whole life insurance is a whole life policy that you pay for in one payment. It’s also referred to as single pay whole life insurance.
It’s a unique policy because you pay for it just once. But is it a good idea?
I co-authored the bestseller What Would the Rockefellers Do? with Garrett Gunderson. In it, we detail the benefits of whole life insurance for wealth planning. Get your free audiobook or hardcover copy to learn more.
Understanding Single Premium Whole Life Insurance
Single premium whole life insurance, also known as single pay whole life insurance, is a permanent life insurance policy. This means it covers you for your entire life.
Term life insurance only lasts for a set period. In contrast, this type of policy never expires as long as the premium is paid. In this case, the premium is paid in one lump sum.
How Single Premium Whole Life Insurance Works
When you buy a single premium whole life insurance policy, you pay a large sum of money upfront. This single payment is your only payment.
From that point forward, you are covered for life. The insurance company invests this money, and the policy builds cash value over time.
The Danger of Single Premium Whole Life Insurance
There’s a danger to be aware of with single premium whole life insurance. That is that it can turn your policy into what’s known as a “modified endowment contract” (MEC). At that point, you lose the tax benefits associated with withdrawals and loans.
An MEC is a type of life insurance policy that holds an excessive amount of cash. This reclassification occurs if you pay too much in premiums too quickly. Once a policy is classified as an MEC, the status is permanent and cannot be reversed.
In the United States, permanent life insurance policies offer attractive tax advantages. However, if you overfund your policy, it transforms into an investment rather than insurance.
The limitations for MECs are based on the terms of the policy and the amount of the death benefit. Your insurance company will notify you if your policy is approaching MEC status.
The IRS designates a policy as an MEC when the premiums and cash value exceed federal limits, which are determined by IRS guidelines for the duration of the policy. This regulation prevents individuals from using life insurance as a tax-advantaged investment.
In the 1970s, insurers provided policies with significant cash value growth. Policyholders could obtain tax-free loans, effectively using these policies as tax shelters. Legislation enacted in 1988 put an end to this practice.
A Better Alternative than Single Premium Whole Life Insurance
To me, single premium whole life insurance doesn’t make any sense. One of the primary benefits of whole life insurance is the tax benefits. So why get a whole life insurance policy only to immediately lose the tax benefits?
There’s only one reason why you might want to use a single premium whole life insurance policy. That is that you have a lot of cash sitting around that you want to put somewhere.
But instead of paying with one payment and losing the tax benefits, there’s a better alternative. It’s called the “premium deposit fund.” It’s provided by the life insurance company and it’s basically a glorified money market account.
How it works is that clients put money into the fund, which right now pays them 5.5%. Then the company takes money from this to fund the client’s whole life policy over a 10-year period.
This way, the client is earning money on his cash while avoiding turning his policy into a MEC.
The following chart shows how it works:
At the end of 10 years, his whole life policy is funded in full. He has earned interest on his money the whole life, while never losing the tax benefits of his policy.
Conclusion
Single premium whole life insurance is possible, but it’s not a good idea. It turns your policy into a MEC and loses the tax benefits.
My recommendation is to avoid single premium whole life insurance. If you have a ton of cash laying around and you want whole life insurance, use the premium deposit fund instead. Make your life insurance premiums over time to avoid negative tax consequences.
My book What Would the Rockefellers Do? can help you make the best life insurance decisions for you. Get your free audiobook or hardcover copy now.