An Introduction to Single Premium Life Insurance

Single Premium Life Insurance (SPLI) is permanent cash value whole life insurance that is purchased with a single large premium. As its name implies, it requires no further premiums to keep the coverage in force for the life of the insured.

Single premium life insurance represents one end of the spectrum in terms of the payment schedules policyowners may choose to purchase lifetime coverage. Ordinary-level premium whole life insurance represents the other extreme. Limited pay policies (for example, where premiums are paid for ten or twenty years or until the insured reaches age sixty-five) represent the middle ground.

In each case, the premiums charged by the insurance company must be sufficient to pay all anticipated death benefits from the group of similar policies issued by the company over the lives of all the insureds. All other things remaining the same, as the number of payments decreases the annual premium, and consequently, the rate of growth of policy cash values, becomes correspondingly larger. Therefore, single premium life insurance, for those who can afford the premium, provides the maximum allowable tax-free investment buildup permitted in a life insurance policy (or tax-deferred buildup, depending on how the proceeds are received).

These policies are designed so that the cash value invested in the policy earns a rate of interest that is competitive with other investments of comparable risk. The initial interest rate is typically guaranteed for one year, although there are some three-year and even five-year guarantees available. These policies also provide a long-term guarantee that the rate credited to cash values in later years will not fall below a certain minimum. Historically, some policies have guaranteed a rate of 6 percent, while others have guaranteed rates ranging up from 4 percent. Over the past decade of quite low market interest rates, insurers have had to lower their guaranteed rates. Over the longer term, insurance companies cannot guarantee to pay rates on their policies that are higher than the rates they can earn on their investments.

Single premium life insurance has existed for many years. However, it increased in popularity after the Tax Reform Act of 1986, which severely limited the tax benefits associated with many other popular tax-sheltered investments. At that time, the tax rules treated single premium life insurance just like any other life insurance contract. Cash values accumulated with no current taxation, death proceeds were paid income tax-free, and the policyowner could borrow against the policy cash values without taxation.

Subsequent legislation diminished this special tax shelter-like status for SPLI. In 1988, congress passed the Tax and Miscellaneous Revenue Act (TAMRA) which created a new class of life insurance contracts called modified endowment contracts (MECs)1 . MECs enjoy fewer tax benefits than other types of life insurance contracts. (See Chapter 22.) Generally, all single premium life insurance contracts issued on or after June 21, 1988 are likely to be MECs. Single premium life insurance contracts issued before June 21, 1988 were grandfathered from the provisions of the new law. However, they can become MECs and lose their favorable tax status under certain circumstances, which are discussed below.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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