Single-Premium Insurance: A Different Way to Pay for Coverage
Published by Stefan Greenberg, CFP®, CFS, CLTC
The volatile markets of the past few years have compelled many investors to alter their asset allocations and replace equity positions with Treasury bills or other safer, short-term investments.
If you are one of these individuals, here’s an idea that may prove more productive over time.
Use some of these funds to purchase the whole life, disability or long-term care insurance you’ve been contemplating. Or pay for any existing coverage with a single-premium approach that will enable you to avoid annual premium payments for as long as you own your insurance.
How does single-premium insurance work?
As its name implies, a single-premium program offers you the option of paying for your insurance with a single, up-front payment, as opposed to annual premiums. In the past, these programs were available only through some insurance providers and then only on new policy purchases. In other words, a single up-front payment could not be used to fund premium payments on an existing policy.
Today, however, there are single-premium programs available that enable you to pay future annual premiums on an existing or new policy by purchasing a single-premium immediate annuity (SPIA). An SPIA generates a guaranteed stream of annual income that begins within a short time after you purchase it (typically 12 months). With this approach, you achieve a number of benefits beyond the convenience of having your premium payments made on time every year.
- Cost effectiveness. The payment required to purchase an SPIA capable of funding future insurance premiums can be substantial. However, it can also be less than the cost you would incur by paying your annual premiums out of cash flow.
- Greater flexibility. With traditional single-premium programs, you are subject to a 10% IRS penalty on withdrawals from your policy’s cash value that exceed the total premiums you paid or loans taken under the age of 59½. With an SPIA-based approach, you can access cash value without penalty.
- Cash management opportunities. The income offered by SPIAs is subject to prevailing interest rates. In a higher rate environment, you have the opportunity to lock in an attractive rate and generate the income required to pay your annual insurance premiums with a smaller up-front commitment.
- More choices. You do not have to purchase your SPIA from the same provider that issues your insurance policy. Rather, you are free to choose the SPIA that offers the most flexible terms available.
How an SPIA works
Massachusetts Mutual Life Insurance Company (MassMutual) recently provided this example of how a single premium with an SPIA compares with simply paying insurance premiums on an annual basis:
- You’re a 55-year-old male planning to retire at age 65.
- The whole life policy you’re thinking about acquiring requires premium payments of $20,000 annually for the next 10 years.
- You purchase an SPIA that will begin generating annual income payments of $20,000 in a year from now.
- The cost of your SPIA is $150,000. In addition, you pay the first year’s premium on your whole life policy ($20,000) for a total expenditure of $170,000.
Comparing your options
Without the SPIA:
- $20,000 annually for 10 years
- $200,000 total premiums paid
With the SPIA:
- $150,000 up-front payment
- $20,000 for first-year policy premium
- $170,000 total payments
- $30,000 savings
A few caveats
- The income generated by SPIAs is partially taxable. In the example above, it is estimated that $3,333 of each $20,000 annual annuity payment is taxable at the annuity owner’s individual tax rate.
- You may withdraw cash from your SPIA, if you need it. However, withdrawals will reduce the income payments made by the SPIA, and you will have to cover any shortfall in premium payments made to the insurance provider. In addition, the annuity provider may impose surrender charges.
- If the annuity owner passes away, his or her beneficiaries can elect to receive the remaining income payments or a lump sum payment.
Clearly, single-premium insurance programs can be complex, but they merit consideration, especially if you:
- Need insurance but have been putting off acquiring it.
- Are receiving a financial windfall or inheritance that can be used to fund your initial, up-front payment.
- Have significant dollars allocated to cash equivalents or other low-yielding investments in an effort to avoid stock market volatility.
Implementing an SPIA strategy can provide you with the flexibility to apply this approach to existing policies, as well as any new coverage you may be contemplating.
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