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Can you buy a life insurance policy with a single payment? Yes, there are ways to do that. Would you want to? In certain instances, it could be useful.
To understand the utility, though, it’s important to understand the general features of permanent insurance.
- Permanent insurance policies offer a tax-free death benefit throughout a policyowner’s life.
- Most types of permanent life insurance, particularly whole life insurance, offer the opportunity to build up “cash value” over time, which can provide a source of funds.1
- The cash value grows on a tax-deferred basis.
But some of these advantages can be curtailed when paying for the policy with a single premium.
That’s because there are limitations on how short premium-periods can be to have a paid-up life insurance policy. In fact, paying up a life insurance policy too quickly turns it into a modified endowment contract (MEC).
A MEC still pays a death benefit and accumulates cash value. But it loses the tax advantages associated with the cash value that permanent life insurance policies build up over time. (Learn more: Mind your ‘MEC’: When life insurance morphs)
For some people, that isn’t a problem; that’s just the type of financial vehicle they want for estate planning purposes and they have no interest in tapping the policy’s cash value. But for others, it might present limitations on the policy’s usefulness.
Avoiding the MEC designation
But there are options. One is to buy a whole life insurance policy and, at the same time, an annuity. An annuity is a contract where a large upfront payment is used to fund a series of smaller payouts at a later date. In this situation, the annuity payouts are used to meet the future premium obligations.
“People like to do this if they have a lump sum available through either an inheritance or a large influx of cash through a bonus or sale of a business,” said Doug Collins, a financial planner with Fortis Lux Financial in New York City. “By doing this, they know they will not have to make premium payments every year but still get the benefits of a traditional whole life insurance policy without it becoming a modified endowment contract.”
Also, while a typical whole life insurance policy is being purchased, in effect, it is being paid for with a single payment, which would be less than the sum of the premiums being paid over time.
So, what situations would a single-premium life insurance policy be appropriate for? Here are three common ones.
Long-term care
A whole life insurance policy can be purchased with a provision ― called a rider ― that allows the policyowner to tap the death benefit should they need long-term care (LTC) for certain types of illnesses or disabilities.
Of course, this kind of rider adds to the cost of the policy.
Nevertheless, some people entering their retirement would find it useful to have the option to be able to draw from their life insurance policy’s death benefit tax free to help pay for long-term care costs if needed. In addition to accelerating the death benefit for LTC costs, some hybrid policies even offer extended coverage beyond the death benefit.
“This is a popular strategy among clients as it offers them a three-pronged approach to their overall retirement needs,” said Nick Tranghese, advanced markets manager for the Planning Solutions Group at Coastal Wealth in Fort Lauderdale, Florida. “The life insurance provides:
- A valuable death benefit.
- Cash value that can be accessed at any time.
- Long-term care coverage in a time of need.
"There is also a major convenience factor for clients knowing that with one payment, a single-premium life insurance policy is fully paid up.”
Indeed, as people approach retirement, priorities sometimes shift from wanting a life insurance policy with a large death benefit that helps provide for children (who have grown up) to a policy that may provide for help managing old age.
“Oftentimes, it makes sense to exchange the cash value in an existing type of insurance policy (like a universal policy), plus outside funds if available, to fund a single-premium whole life insurance policy with a large long-term care benefit as part of the policy,” said Collins. “This way, they retain the access to their cash, continue to have some permanent death benefit (though usually less than before) but more importantly, know they will have at least some long-term care coverage if and when they need it.”
Funding a trust
Life insurance proceeds can be used to fund a trust. A trust can have a variety of uses. Some people use them to establish a testamentary trust upon their death or specifically provide for a loved one, like a child with a disability or special needs. (Related: 7 situations where a trust might help)
Trusts can be funded with the death benefit proceeds of a life insurance policy. Indeed, that provides financial leverage. Life insurance can provide a significant death benefit in relation to the total in premiums paid, so the trust may benefit more in the long run by being funded with a policy death benefit in the future than just a single payment now.
Setting up the trust with a single-payment whole life insurance policy means that, because the premiums are paid in advance, the death benefit is guaranteed ― no additional premiums will be required.
Final expenses and leaving a legacy
Leaving behind a financial legacy for loved ones is important for many people. For some, it may be a matter of just making sure burial costs and other end-of-life expenses aren’t a burden to those left behind. For others, it may be a desire to help family or dear friends get ahead.
Again, life insurance offers significant advantages for transferring wealth. The death benefit is tax free and can be significant compared with the premium paid. Additionally, the death benefit can provide immediate cash resources to cover funeral expenses and can be easily divided among heirs. (Related: An estate planning tool for the not-so-wealthy)
Conclusion
Paying for a life insurance policy with a single payment is not for everyone. It requires the wherewithal to make a large, upfront payment. And, if you die earlier than expected, you may have paid more in premium for the death benefit than you needed to. (Related: Short vs. long premium whole life policies: The difference)
Nevertheless, paying for the entire policy upfront is comforting to some people, especially if they believe their income may decline in later years, perhaps making premium payments challenging. And, beyond the death benefit, it also allows cash value generation, which can build quickly depending on the premium schedule, along with the accompanying tax advantages.
A MassMutual financial professional can help map out what options may be best for your situation.
Discover more from MassMutual …
A way to approach 3 typical estate planning needs
Taking cash off the table: Life insurance, annuity alternatives
Life insurance premium options: Which one is right for you?
This article was originally published August 2020. It has been updated.
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1 Borrowing against life insurance cash value increases the chances that the policy will lapse, reduces the cash value and death benefit, and may result in a tax bill if the policy terminates before the death of the insured.