During an era in which there seemingly is a financial or insurance instrument to account for every possible client scenario and need, it’s easy to overlook a product such as single-premium life insurance. While a new generation of financial planning instruments has emerged with highly specialized designs and complex features targeted specifically at narrow segments of the senior market, single-premium life insurance has itself been evolving. And in doing so, it appears to have found its niche in the 21st century as a wealth transfer and estate preservation tool.
There’s a widely held view that single-premium life insurance is merely a throwback from a bygone era of financial planning. It’s a once-popular product whose heyday – and utility – ended in the late 1980s with the implementation of federal laws that eliminated many of the tax advantages associated with owning a single-premium life policy. Granted, demand for single-premium insurance is nowhere near what it was prior to 1988, when Uncle Sam slapped a “modified endowment contract” label on the product and ruled that cash values generated by policies could no longer be accessed without additional tax liability for the policyholder.
Nowadays, however, insurance carriers continue touting single-premium products in the senior market, and advisors continue recommending those products to senior clients in certain narrow circumstances – typically in cases where there’s plenty of liquidity available to purchase a policy and the primary goal is to protect assets and/or transfer wealth to heirs.
“Today you see [single-premium life insurance] used in a very limited way,” says Georgene M. Grattan, CFP, president of Grattan Financial Strategies in San Gabriel, Calif., “because there are not many people it applies well to.”
Grattan doesn’t often recommend SPLI to senior clients, but when she does, it’s usually in the context of an estate plan involving an irrevocable life insurance trust. Most likely, she explains, it’s a married couple in the 65- to 75-year-old range whose current insurance policy has accumulated substantial cash value since it was purchased.
“As these people mature,” she says, “they are looking for insurance to solve another issue: estate preservation.”
Thus, they take cash from the existing insurance policy (or from other accounts) and gift it to the ILIT, which typically is held by a child or children, the heir(s) to the estate. Then that money is used by the trust to purchase a second-to-die single-premium life insurance policy. Not only is the money that purchased the survivorship policy now removed from the couple’s estate for tax purposes, notes Grattan, the couple’s heirs (as beneficiaries of the policy) gain access to the death benefit on a tax-favored basis to cover estate taxes. Further, purchasing SPLI instantly leverages the upfront premium investment with the promise that heirs will receive a guaranteed death benefit that is usually several times the amount of the initial payment. That payment earns interest that compounds income tax free and beneficiaries ultimately receive the death benefit income tax free, without the delay and cost of probate.
“Using a product like single-premium life insurance works out very well for the senior client in those types of scenarios,” says David W. Hoffmann, CFP, a financial planner for D.B. Root & Co. in Pittsburgh.
A client’s purchase of a single-premium product can work out pretty well for the advisor, too, since these products often carry hefty commissions – sometimes in the neighborhood of 10 percent to 12 percent.
The glass slipper
But as Hoffmann points out, the size of a commission is a moot point when the product doesn’t suit the client. And with single-premium life insurance, according to advisors, only a couple suitable applications exist for senior clients: the ILIT scenario (or similarly, a scenario involving a charitable trust) for wealth transfer being one, and wealth preservation being the other. Using single-premium insurance to protect assets is a relatively new approach, one that has become viable only in recent years, as insurance carriers began offering products with a feature or rider that allows policyholders to take money out of a policy tax- and penalty-free specifically to cover the cost of long-term care.
“If there’s a need for life insurance and a secondary need for long term care insurance, that’s another very specialized scenario where single-premium life insurance might make sense,” Hoffmann says.
Since the late 1990s, insurance carriers have been targeting that niche by developing combination products: single-premium insurance policies, usually built on a whole life or universal life chassis, with an LTC coverage component.
Combination policies offer the benefits of traditional SPLI products, such as an estate-enhancing, guaranteed death benefit, the ability to secure coverage that is several times the amount of the initial investment, as well as cash values that may grow more quickly because the premium is paid upfront. And in the case of products such as New York Life’s Asset Preserver, they also allow immediate, guaranteed access to funds to cover LTC expenses via tax-free acceleration of the death benefit, with flexible coverage options for LTC expenses. These days, some single-premium products also come with lifetime return-of-premium guarantees, as long as there have been no policy loans or partial surrenders, nor any LTC benefits paid. If LTC benefits are paid from a policy, any remaining death benefit passes to beneficiaries income tax free.
Such products are best suited to seniors who have a need for both life insurance and long term care insurance, and who also have enough cash to be assured they won’t need access to the money they’re using to buy the policy. That kind of money often resides in a client’s slow-growing “rainy day fund,” such as a CD, points out Scott Berlin, senior vice president in charge of individual life insurance at New York Life. Rather than keep that lump sum in the CD, they can use it to fund an SPLI policy with an LTC component.
“You’re immediately leveraging those assets, so you can make an investment of $50,000 look like $100,000,” Berlin says.
In addition, he says, giving a policyholder the ability to tap into a policy’s death benefit to cover long term care costs “is a great leveraging feature,” one that appeals particularly to seniors with inadequate or nonexistent LTC coverage. With an LTC component, an SPLI policy becomes more an asset protection tool than a wealth transfer tool, giving clients protection from the potentially volatile and asset-draining costs of long term care.
That protection, coupled with a return-of-premium feature and other guarantees, appears to resonate with seniors and the insurance agents who serve them. Put those features together and you have a product that, according to Berlin, caters directly to the “middle and upper-middle senior market.”
Today’s SPLI marketplace
The market for SPLI may be much narrower than it was prior to 1988, but that hasn’t stopped companies like New York Life, Bankers Life, MetLife, Northwestern Mutual, Liberty Mutual, AmerUs Life Insurance and others from attempting to take the product in new directions, the senior market among them. Nor has the MEC status of single-premium life products stopped advisors such as Hoffman and Grattan from recommending SPLI to senior clients in certain situations where they perceive an investment in the product to be warranted.
Today, advisors have a growing array of other SPLI products from which to choose. Liberty Mutual, for example, offers the Estate Maximizer II single-payment whole life product that can be designed as a survivorship policy to work within an ILIT. MoneyGuard from Lincoln Financial Group combines universal life with LTC benefits, including nursing home care, home health care, assisted living and adult day care. For an additional cost, the policyholder can purchase a rider that continues LTC benefit payments after the entire death benefit has been exhausted. Another rider is available that protects LTC benefits against inflation.
In late 2005, AmerUs introduced two single-premium products, one with a fixed-rate crediting mechanism and the other with an indexed crediting feature tied to an index such as the S&P; 500. It’s a product, says Gary R. McPhail, president and CEO of AmerUs Life Insurance Group, “for those buyers who are considering an annuity product but have no plans to access the funds.”
Why not access the cash in an SPLI? Because since 1988 the IRS has treated them much like tax-deferred annuities, with loans or withdrawals considered taxable earnings and an additional 10 percent tax imposed on distributions made by the policyholder prior to age 59 1/2. Prior to 1988, policyholders could withdraw the interest earned by a policy tax free.
Carriers also offer SPLI products built on a variable universal life chassis. But those products are better suited to younger, less risk-averse clients such as baby boomers, Berlin, Grattan and Hoffmann agree.
“I have a serious problem with using variable insurance products with seniors,” Grattan explains. “I feel strongly that whatever investments they make in variable accounts should be made independent of the insurance component of the portfolio.”
Grattan professes to feeling equally strongly about finding products that precisely fit the needs of her senior clients. Sometimes – though not nearly as often as in the 1970s and 1980s – she will turn to single-premium life insurance to meet those needs. That’s when being an advisor really pays dividends.
“I was working recently with a couple and we decided to use the accumulated cash value [of their life insurance] to buy a second-to-die, single-premium policy,” she says. “Not only did that triple the value of their insurance, it took care of their estate tax exposure entirely. They were ecstatic. What a great feeling to be able to do that for someone. It’s the most gratifying part of my job.”