Single-Premium Life Insurance? Your Answers to 10 Important Questions

What’s Good, Bad, and Different About Single-Premium Life Insurance?

Life insurance is crucial in many cases and a near-total waste of money in others.

Even when life insurance is a good idea, you may be better served by term life insurance rather than permanent life insurance.

Finally, if permanent life insurance is right for you, single-premium insurance may or may not be best for you.

Here are 10 crucial questions you should be asking and their answers.

1. Should You Get Life Insurance?

That depends.

Is there anyone who depends on you continuing to breathe and do what you do? Do you have a spouse, kids, aging parents, partners, etc., who count on you for your income and/or expertise?

If your answer to that latter question is yes, then so is your answer to the first question.

If your answer was no, why are you still reading? 😉

Seriously though, there is one other possible reason to buy life insurance before you actually need to insure your income for people who depend on you. If you expect to need insurance in the future, getting a policy in place early lets you get higher coverage for a lower cost when you’re younger and healthier.

2. Should You Buy Term Life or Permanent Life Insurance?

Assuming you’re at least considering buying life insurance, your first decision needs to be whether you want pure insurance for a limited length of time, or if you want to combine life insurance coverage with a (very conservative) investment component.

Many experts will tell you that your best bet is to buy a term life insurance policy, which is far cheaper than the permanent sort (e.g., universal life insurance, whole life insurance, etc.), and invest the money you save by not paying for the investment component of permanent life insurance.

However, some reasons may make permanent life insurance the right move for you:

• You want insurance that doesn’t end after a set number of years and where premiums stay fixed.
• You want to be able to access the cash value (e.g., by borrowing from it) in case of emergencies.
• You want to get affordable long-term care coverage, which can be done as part of permanent life.
• You want to access part of the death benefit in case of, e.g., terminal illness, no matter your age.
• You want to use life insurance as part of your estate planning.

Because permanent life has an investment component, you can usually use part of the investment returns to eventually pay your premiums once your investment portion grows large enough.

3. What Is Single-Premium Life Insurance and What Is a Modified Endowment Contract (MEC)?

The name says it (almost) all.

Single-premium life insurance is a (permanent) life insurance policy that you set up and fully fund with a single initial premium payment.

Life insurance death benefit size depends on your age and health when you’re approved for coverage, as well as how much you’re willing to pay in premiums.

Because you’re paying all the premiums at once, when you’re the youngest you’ll ever be during the duration of the policy, the cost relative to the death benefit is lowest (compared to other permanent life insurance options). 

For example, young people can get a death benefit of $10 or more for every dollar of their single premium!

So, what is a Modified Endowment Contract (MEC)?

A MEC is a life insurance policy purchased after June 20, 1988 that fails the so-called “seven-pay test.” That’s where you pay more in premiums than is needed to fully fund the policy in seven years. Since single-premium life insurance policies are all fully funded from Day 1, by their very definition all such policies fail the seven-pay test, making them MECs.

Why is this important here?

MECs are treated differently than other life insurance policies from a tax perspective. For example:

• You can’t reverse them.
• If you take money out or borrow against the cash value before you are 59½ years old, you’d pay a 10% tax penalty along with income taxes on withdrawn amounts.
• Withdrawals from other policies are taxed based on a last-in-first-out basis, whereas on single-premium policies, it’s based on first-in-first-out, maximizing taxes due.

4. What Are the Investment Options of Single-Premium Life Insurance?

Permanent life insurance, as mentioned above, has an investment component to it.

If the investment aspect is important for you (otherwise, you should buy term life insurance and invest separately from the policy), you’d want to know the so-called Internal Rate of Return (IRR). The problem is that you can’t know the actual IRR of any life insurance policy because you don’t know how long you’ll live past the day you purchase the policy. 

If you buy a policy that isn’t single-premium and die the next day (assuming the carrier doesn’t determine that you died intentionally), the IRR can be enormous – perhaps greater than 1000% (as mentioned above, when you’re young and healthy you can buy over $10 in death benefits per premium dollar). However, if you live a long life or buy a single-premium policy, your IRR could be under 5%.

What investment option you choose will be based on your budget and willingness to take on risk.

Single-premium life insurance isn’t primarily designed to be an investment, but it does have a cash-value component. Like with other permanent life insurance policies, you can buy various options:

• Single-premium universal life: The least expensive option is the so-called Guaranteed Universal Life (GUL) insurance. This provides the same lifetime coverage as all permanent life policies with the smallest tax-deferred growth of cash value of such policies. As a result, GULs offer the highest death benefit per dollar in premiums with the least cash value growth.
• Single-premium whole life: Whole Life (WL) insurance also gives you permanent death benefit coverage along with cash value that grows at a guaranteed interest rate determined by your insurance carrier. These policies are usually offered by mutual insurers, who are owned by the policyholders. This means you may be paid dividends, which you can take out as cash, add to your policy’s cash value, reduce your premiums, or increase your death benefit.
• Single-premium indexed life: Indexed Universal Life (IUL) insurance does as its name implies. It provides permanent life insurance coverage with cash value that grows based on the index you prefer among the options offered. These can be the S&P 500, the Dow Jones Industrial Average, or the NASDAQ. This doesn’t mean that your cash value is invested in any of these indexes. Rather, the insurer links your cash value growth to the index you picked, but with a floor that prevents you from losing money but caps your cash value growth, potentially far below the actual growth of the index.
• Single-premium variable life: Variable Universal Life (VUL) insurance invests your cash value in mutual funds. While you may experience higher growth, you also risk losing money. This is the least-conservative approach to permanent life insurance.

Which option you choose should be informed by how risk-averse you may be, at least with this portion of your finances, and whether and how you plan to use your policy’s cash value. 

Because WL, IUL, and VUL typically place a higher emphasis on building cash value, fewer dollars go to cover the death benefit, making them more expensive per dollar of death benefit.

5. What Are the Pros of Single-Premium Life Insurance?

Single-premium life insurance has several benefits that make it a good fit for people in certain circumstances (see below for some examples).

• Like all permanent life policies, the single-premium variation offers lifelong death-benefit coverage.
• Your beneficiaries receive a tax-free death benefit (if they collect it as a lump sum), without having to wait or suffer the expense of probate.
• Because it’s paid up from Day 1, single-premium life insurance will never lapse for non-payment of premiums.
• The cash value grows tax deferred.
• If purchased from a mutual carrier, you may receive tax-free dividends.
• Subject to the implications of it being a MEC, you can withdraw or borrow against the cash value,
• You may purchase riders that offer living benefits (see below).
• In some situations, a single-premium policy can be a useful estate-planning tool.

6. What Are the Cons of Single-Premium Life Insurance?

As with everything in life, single-premium policies also have drawbacks.

• Like all permanent life insurance policies, the premiums are far higher than those of term life.
• Since you’re paying all the premiums upfront, that initial cost is far higher than the monthly premiums paid over years or decades, making it much harder to afford. For example, the minimum premium can be $5000 or higher, but that may not provide a large enough death benefit for your needs (e.g., paying off a mortgage plus providing for a surviving spouse’s needs).
• If you die young, you could have paid far less by not prepaying all premiums.
• Unless you withdraw it before you die, your cash value reverts to the insurer upon your death, and your beneficiaries receive just the promised death benefit.
• Surrender fees are typically high, especially during the first several years of the policy.
• Because single-premium policies are all MECs, withdrawals or loans taken before age 59½ come with a 10% penalty; withdrawals are also taxed.
• Also, due to being a MEC, you can’t add contributions to the specific policy once it’s purchased.

7. What Are the Living Benefits of Single-Premium Life Insurance?

Life insurance policies are primarily intended to provide for financial needs that will arise upon your death. This can include paying off the mortgage to allow your spouse to keep living in your family home without the risk of foreclosure if he or she can no longer afford those payments without your ongoing income. It may also provide a stream of monthly payments that offset the difference between the loss of your income and the far smaller reduction in monthly expenses once you’re gone.

However, life insurance, including single-premium policies, can offer a variety of benefits while you’re still alive. For example:

• Tax-free access to a portion of the death benefit if you need long-term care. If you take advantage of this benefit, it will reduce the death benefit received by your beneficiaries.
• With a similar caveat, you can access some of the death benefits while still alive if you’re diagnosed with a terminal, critical, or chronic illness. Terminal illness is typically defined as having no more than a year left to live.

8. What Are the Withdrawal Options of Single-Premium Life Insurance?

As with other permanent life policies, you can withdraw or otherwise access the cash value in your policy. However, as mentioned above, since the IRS considers all single-premium policies to be MECs, there are significant tax consequences, especially if you’re younger than 59½.

For example, you can take out a loan typically up to 90% of your policy’s cash surrender value. Note that until and unless you repay the loan, you’re reducing the policy’s death benefit and cash surrender value.

If you want, and subject to tax implications, you can usually withdraw annually with no surrender charges the higher of 10% of the premium you paid or all the policy gains.

9. What Are Some Good Examples of Using Single-Premium Life Insurance Well?

Here are some examples of when it makes sense to consider a single-premium life insurance policy:

• You want a quick, simple, and inexpensive (relative to the coverage amount) way to provide a tax-free death benefit to beneficiaries and have a large sum available to cover the high cost of the single premium (e.g., you just received a windfall such as an inheritance or a settlement).
• You’re a senior who wants a way to buy permanent life insurance without ongoing premium payments, for example, to significantly increase what you can leave for your heirs relative to the conservative portfolio in which you’d otherwise invest.
• You’re a senior and want to be able to access the cash value of your life insurance policy to cover the costs of, e.g., healthcare, a grandchild’s college costs, long-term care, etc. With a single-premium policy, you’d be able to access 90% of the premium you pay since you’re older than 59½, and many of the tax consequences of MECs no longer apply. 
• You want to change an existing policy with ongoing premium payments into one where you no longer need to pay monthly premiums. You can do this using a so-called Section 1035 exchange.
• Your estate-planning lawyer suggested a single-premium policy to move assets out of your taxable estate.

Jeremy Keil, CFP®, CFA, Financial Planner with Keil Financial Partners, says, “I recommended Single Premium Whole Life (SPWL) to two clients just this morning, suggesting they use it to pre-plan, but not pre-pay their funerals. When you ‘pre-pay,’ you’re buying a guaranteed-issue, high-commission life insurance policy through the funeral home. If you’re in average health or better, you’re better off buying your own life insurance, and SPWL insurance is a great way to do it. Both clients should save almost 30% (the same $10k benefit will cost them $5k for SPWL vs. $7k for funeral-home pre-payment).

“SPWL policies can also serve as an alternative to fixed annuities and CDs if you want your money to be available but don’t think you’ll ever use it. They have similar returns, but the taxation is far different. Annuities grow tax-deferred, but you’ll end up paying taxes. CD interest is taxable as you go. SPWL yields similar interest, but if you die with the interest in the policy, it pays out as a tax-free death benefit. That said, in today’s interest rate environment, CDs and annuities pay ~5% for 1-7 years, which SPWLs can’t match. It was a good deal from 2009-2021, and once rates drop, it’ll likely be a good deal again.”

10. Who Should Not Buy Single-Premium Life Insurance?

On the other hand, here are some situations where a single-premium life insurance policy would be inappropriate:

• You can’t afford to pay for enough coverage with money you have on hand and that you won’t need for many years.
• You prefer to pay premiums over time, so you don’t pay more than you must if you die young.
• You want the flexibility of adding to an existing policy to increase the death benefit.
• The tax implications of a single-premium policy being a MEC don’t work for your financial situation.
• The investment options offered in these policies are too conservative for you.
• Your investment advisor and/or estate attorney advise against it.

The Bottom Line

The above addresses 10 crucial questions you need answered to figure out if a single-premium life insurance policy may be right for you.

However, life insurance can only be sold by licensed insurance agents. There is a good reason for this. There are so many life insurance options that it takes a great deal of knowledge to identify the best option for any given financial situation, family situation, goals, and/or level of risk aversion. Even if you decide to buy such a policy, you may be better served by specifying someone else as the insured but keeping the policy in your name so you can still access the cash value.

All this means that in this matter, more than most financial decisions, you must consult with the relevant financial experts – an insurance agent as well as an estate attorney, accountant, and/or other advisor – consider a professional such as a financial advisor who has earned their Chartered Life Underwriter (CLU) designation. When you do, make sure they consider other relevant factors, such as what other life insurance policies you may already have, what other investments you own, and how much you plan to set aside and invest annually.

Jorey Bernstein, Executive Director, Wealth Manager, and Founder, Bernstein Investment Consultants agrees, “Single-Premium Life Insurance can be a powerful tool in estate planning for those with a significant lump sum to invest, offering a guaranteed, tax-free benefit to heirs. Yet it isn’t suitable for everyone, especially for those seeking aggressive investment growth or needing liquidity. As always, personalized financial advice is key.”

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.