A key attraction to permanent life insurance is that it provides not only a death benefit when you die but accumulates a cash value from which you can borrow while you’re still alive. But access to that cash is usually slow in coming. You typically have to wait some years before the cash account, funded by policy premiums and the investment interest they earn, grows large enough to be tapped through a loan.
Single-premium life insurance allows you to accelerate that process, by paying the policy premiums in full upfront, in a lump sum. Supercharged by that single payment, the policy’s cash account can be drawn upon sooner than is the case for a traditional permanent insurance policy.
The single-premium arrangement also spares you from having to schedule monthly or quarterly premium payments. It’s one-and-done life insurance.
However, these policies require a hefty upfront contribution that might be unaffordable for many people. And while you can borrow earlier in the life of the policy than with a single-premium policy, you’ll be taxed on the amount you draw out from a single-premium policy. That drawback doesn’t apply to traditional coverage, the premiums for which are paid in installments over many years.
This guide covers what single premium life insurance is, how it works and whether it might be right for you if you’re in the market for permanent life insurance.
What is single premium life insurance?
Whether you're considering term or permanent life insurance, including whole life insurance, you need to pay premiums on the policy. Traditional coverage typically requires that payments be made every month, quarter or year. By contrast, a single premium life insurance policy (which is available only as permanent life insurance), requires you to pay only once. The jumbo lump-sum payment replaces the intermittent premiums a regular policy demands.
This single super-premium pre-funds the policy. That brings two key advantages. The first is to eliminate the need to make ongoing payments. More importantly, pre-paying allows you to borrow from the account’s cash value sooner, thanks to the infusion of funds from the single payment. Those funds typically begin to earn interest immediately, and the investment earnings are available to borrow.
But a positive interest balance, while likely, is not guaranteed, and here’s where the single-sum arrangement can pose a drawback. With certain types of single premium policies, you may not be one-and-done if the investment value in the account drops. You may then have to pay additional premiums, to ensure the account stays in positive territory, as the insurance company will require.
How does single premium life insurance work?
Single premium life insurance is a permanent life insurance policy that you purchase in advance with a one-time payment. Once you pay, the insurance company provides you with a policy that remains active for your lifetime or until you decide to surrender it.
Immediately after you make the payment, the policy typically starts accumulating cash value from interest on that payment. This cash value customarily grows over time, usually on a tax-deferred basis. The insurance company invests this cash balance either at a fixed interest rate or in market-linked funds, depending on the type of single premium policy you choose. You needn’t pay taxes on the cash value gains unless you withdraw them.
You can opt to borrow against your life insurance – from its accumulated cash value, specifically – if you find yourself in need of funds and have no better option. Be cautious, though. If you don’t repay the loan, the insurance company will recoup the unpaid balance from the policy’s death benefit, which could reduce how much your beneficiaries will receive upon your death. Also, withdrawals you make from single premium policies are taxable, because these products are considered by the IRS to be primarily for investment purposes. (See the Drawbacks section below for more on this downside.)
You also have the option to surrender the policy before you die. But there’s a wrinkle here as well. You may face a high surrender fee that will reduce the cash value you can take away.
When you die, the insurance company pays out the death benefit to your designated beneficiaries. This payout typically combines the policy's face value – its death benefit – and any remaining funds in the cash-value account. However, the specifics can vary depending on the terms of your policy.
Types of single premium life insurance
If you’ve absorbed the lessons from life insurance for beginners, you'll know that there are basically two types of life insurance, permanent or term, each with variations. Single payment life insurance is invariably permanent life insurance – there being no such thing as single premium term life insurance.
Single premium insurance is available in all the major types of permanent insurance: whole life insurance, universal life insurance or variable life insurance policy.
Single premium whole life insurance
With single premium whole life insurance, you make a one-time payment and, in return, secure a guaranteed death benefit that lasts your entire life. This prepaid life insurance policy offers a fixed interest rate, which ensures a predictable growth rate for your cash value - but also precludes the more dramatic gains (and losses) that are possible with the accounts of other types of permanent insurance. To achieve such predictability, the insurance company manages the funds in a whole life account conservatively, often investing them in bonds or other low-risk investments.
Single premium universal life insurance
With universal life insurance, of the single premium variety or not, the cash value of life insurance is usually dependent on the performance of the stock market. Consequently, universal single premium life insurance has the potential to provide higher returns than a whole life single-premium policy, but also the possibility of lower growth than that. However, there’s typically both a cap on how much the account can appreciate and a guarantee that its value will not fall below that amount of the payment, or payments, made to the policy.
Single premium variable life insurance
A single premium variable life insurance policy offers the most flexibility and control of all but is also subject to the highest risk. You choose how to invest your cash value from options managed by your insurance provider; you generally face a choice between index funds and money market accounts.
The benefits of single premium life insurance
Single premium life insurance policies let you “set it and forget it,” so life insurance isn’t an ongoing obligation. They also offer other benefits that make them an appealing option.
A head start on building cash value
Traditional permanent life insurance, with premiums paid periodically, has a slow build when it comes to building cash value. Premiums, and the interest they earn, in the policy’s cash account, must accumulate for a year or more before you can borrow from your insurance.
By contrast, the all-in-one opening payment of single premium life insurance allows the policy to enjoy a robust cash value balance from the get-go. That means you can take out a loan from the cash account far sooner than with a policy whose premiums are paid monthly, quarterly or annually.
No risk of policy lapse due to late payments
A single premium life insurance policy is fully paid up from its inception. That means there’s no need to arrange payment of the premiums on their due dates, or to struggle to pay them should your finances take a turn for the worse.
More importantly, the single premium payment ensures there’s no risk of missed or late installments. Such late payments could trigger late charges or even a lapse of the policy, if you get too far behind. With single premium life insurance, once you make the initial payment, the policy stays in force for your lifetime or until you choose to surrender it.
The drawbacks to single premium life insurance
The pluses to single premium life insurance are offset by a number of drawbacks. Consider the following before you decide what one of these policies will align with your financial goals or circumstances.
Significant upfront cost
Single premium life insurance requires making a single substantial payment. This immediate financial outlay could be a burden and might deplete savings or liquid assets you would otherwise use for alternative investments or other purposes.
Loans are taxable
Single premium policies aren’t treated the same by the IRS as traditional life insurance. Under the agency’s rules, single premium life insurance is deemed to be an investment vehicle first and an insurance policy second. Consequently, these policies are classified by the IRS as modified endowment contracts (MECs), and any gains in their cash value are treated as income if and when money is withdrawn.
That means that if you borrow from the cash value of a single premium policy, you lose the tax sheltering that occurs with a loan from a traditional policy. The amount borrowed becomes taxable income, and you may incur an additional penalty of 10% if you're under 59-1/2 years old.
Relatively high surrender charges and penalties
If you want out of a single premium policy, the move will be more costly than with traditional coverage. Traditional policies, too, are subject to surrender charges for canceling the policy, which are deducted from the cash balance due to you. But the charges are higher for loans from a single premium policy, especially if you cancel the policy early in its lifetime.
Single premium life insurance vs. traditional life insurance
Single premium life insurance is available in all three types of permanent policies – whole, universal and variable life – and shares many attributes of traditional policies with typical payment schedules. However, there are also some significant differences between traditional and single-premium policies.
Single premium life insurance requires you to make one large upfront payment to cover a policy’s premiums for your lifetime. The single premium eliminates the need for future payments. Traditional life insurance, by contrast, demands an ongoing financial commitment. You must make regular premium payments — either monthly, quarterly or annually — for as long as the policy dictates.
Cash value accumulation
Both types of policies offer cash value growth, but single premium policies usually start accumulating cash value more quickly because of the substantial initial investment from the single sum payment. Traditional life insurance policies take time to build cash value, often requiring several years of payments before the balance is large enough to facilitate a loan.
Policy lapse risk
With a single premium policy, there's no risk of the policy lapsing due to missed payments, as you've made all necessary payments upfront. In traditional life insurance, failing to make scheduled payments can lead to a lapse in coverage, leaving you unprotected.
Traditional life insurance policies obviously offer more flexibility in terms of payment options and coverage adjustments. You can often decrease or increase your death benefit or even skip certain payments under predefined conditions. Single premium policies have no payment flexibility, of course, and are often less easy to alter in other respects as well.
Both traditional and single premium policies offer tax-deferred growth of cash value, along with a tax-free death benefit. However, since the IRS categorizes single premium life insurance as primarily an investment vehicle (see the Drawbacks section above), withdrawals from an MEC are subject to income tax and potential penalties. With a traditional life insurance policy, by contrast, withdrawals are tax-sheltered.
Surrender charges and penalties
Canceling a single premium policy often results in higher surrender charges, especially during the early years of the policy. Traditional life insurance may also have surrender charges, but these are usually lower and diminish more rapidly over time.
Suitability for financial goals
Single premium policies are best for people who have a large sum of money they wish to invest for the long haul in a tax-advantageous vehicle that also provides a death benefit. Traditional life insurance suits those who prefer spreading out premium payments and might wish to borrow from the account’s cash value without incurring a tax bill in the process.
How long does the single premium payment cover you?
In a single premium whole life insurance policy, the single lump sum payment you make to open the account covers you for your entire lifetime. You're guaranteed coverage without any additional payments required, provided you don't surrender the policy or take actions that would otherwise nullify it.
The policy remains in force until you pass away, at which point the death benefit is paid out to your designated beneficiaries. This lifetime coverage is one of the key features that distinguishes single premium policies from traditional term or whole life insurance policies, which require ongoing premium payments.
Is single premium life insurance a good investment?
Single premium life insurance is a niche financial product that won’t be the best life insurance option for most people. Under most circumstances, you’ll be better off with a traditional life insurance policy, which isn’t classified as an MEC and so has the more favorable tax treatment. However, single premium life insurance can be a good investment if you:
- Have a large sum of money that you can afford to put away for a long period
- Want peace of mind from a guaranteed death benefit, without the fear of missing payments
- Are looking for tax-advantaged growth
- Don't anticipate needing to access these funds for short-term needs
Summary of Money's guide to what single premium life insurance is
Single premium life insurance allows you to purchase lifetime coverage through making a one-time payment when the policy is opened. That makes for a simple arrangement, and one that allows you to take out a loan from the policy’s cash value sooner than with a traditional policy, whose cash value builds more slowly.
But where loans taken from a traditional policy are shielded from tax, those from a single-premium policy are taxable. And the single premium requirement demands assembling a sizable amount of money, which could otherwise be employed for other purposes.
Those drawbacks prompt many financial advisors to advise against single premium life insurance, at least for most people. However, one of these policies might make sense if you have ample cash on hand and are primarily buying life insurance coverage as part of your estate planning.
As with a traditional policy, single premium coverage allows you to pass along a death benefit to your beneficiaries free of tax. And as with that regular coverage, cash-value earnings from a single premium policy accumulate in a tax-deferred manner, meaning you needn’t be taxed on those gains during your lifetime unless you take out a loan from them.