When it comes to financial planning, clients have a wide variety of goals that extend far beyond simply securing a monthly income stream during retirement—which means that standard annuity and life insurance products may fall short. Specifically, many higher-income clients are concerned with providing for children and other beneficiaries while also maintaining access to their savings during retirement, so that the surrender charges and tax consequences that are often associated with a traditional annuity can make the products unappealing.
For the right client, a single premium whole life insurance product may provide the gateway for achieving all of their planning goals and more—with the added benefit that these policies can provide a significant tax benefit that generally doesn’t apply to annuities.
Single Premium Whole Life Insurance Defined
As the name suggests, single premium whole life insurance is permanent life insurance that is purchased with one single payment, rather than through a series of premium payments over time. For many clients, this payment structure is appealing because it eliminates the risk that premiums will rise to an unacceptable level over time, so that the client may be tempted to let the policy lapse.
Because most of these policies will be taxed as a modified endowment contract (because the premiums are paid up front), withdrawals (loans) against the cash value of the product will generally be taxed in the same manner as any other annuity. These loans can also subject the client to IRS penalties if the client has yet to reach age 59 ½ when he or she makes the withdrawal. Some policies will, however, allow tax-free withdrawals to pay for long-term care expenses.
Despite this—and importantly—the death benefit on a single premium whole life insurance policy passes to the client’s heirs tax-free just like any other insurance product, giving it a substantial advantage over a standard annuity product if the client’s goal is to provide for his or her heirs. Further, the inheritance will avoid probate, thus simplifying the process for the client’s beneficiaries.
Like many other investment products, the cash value of the policy will grow tax-deferred until the funds are accessed or the policy is surrendered. Growth within the single premium whole life policy can be fixed or variable—meaning that the cash value can grow at a fixed rate, or can vary based upon market conditions in the subaccounts that are associated with the policy.
When the Product Fits
Generally, the ideal candidate for a single premium whole life insurance product is a client who is nearing retirement (or who has retired) and has easy access to the lump sum necessary to fund the purchase (while some products can be purchased for less, most of these policies require a payment of $40,000-$50,000).
It is important that the client allocate funds to the policy that he or she had already intended to pass to heirs—if the client can anticipate a future need for the funds, a vehicle that allows for tax-free withdrawals under any circumstances may be more appropriate.
Most clients who purchase single premium whole life insurance will have a specific beneficiary in mind when purchasing the product—many clients with special needs beneficiaries are attracted to these types of policies. Because the premiums are paid in advance, the eventual death benefit is guaranteed regardless of whether the client can afford premium payments for the rest of his or her life.
Single premium whole life insurance is a product that advisors often fail to consider, largely because the associated modified endowment contract tax treatment adds complexity. For clients who have specifically earmarked funds for the next generation and who want to avoid ongoing premium payments, however, the product can provide a valuable solution.
See these additional blog postings by Professors Bloink and Byrnes:
New Social Security Rules: How to Maximize Benefits
Originally published on Tax Facts Online, the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.
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