Problems With Single Pay Life Insurance
Life insurance is a financial tool used to provide your beneficiaries with a death benefit after you die. This death benefit may be used for any purpose. However, the life insurance policy also often comes with a lifetime of premium payments unless you choose a special type of policy called a single pay life insurance policy. While these policies may seem attractive at first, you should be aware of some of the problems with them.
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One Premium Payment
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Single premium life insurance only requires one premium payment and the policy is paid in full. However, this also means that no further premium payments are allowed. This prevents you from making more premium payments in an attempt to increase the cash value of the policy, if this happens to be a goal of yours. Instead, you must rely on favorable investment performance for the cash value of the policy to be increased.
Death Benefit
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Single pay life contracts have a low death benefit relative to the premium you pay. This is because single pay life is a paid up cash value life insurance policy. In order for the policy to be paid in full, the cash value must replace most of the death benefit that would ordinarily be purchased when buying a life insurance policy. The interest generated by the cash value account must be sufficient to pay any death benefit costs of the policy without requiring any future premium payments. This presents a problem if you want or need a lot of death benefit because the cost of the death benefit becomes extremely high to achieve a paid up policy.
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Violates MEC Guidelines
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Single pay life policies violate IRS MEC guidelines. A MEC is a "modified endowment contract." Modified endowment contracts do not have the same tax benefits that life insurance policies have. In particular, the cash value inside the policy is tax deferred, but any withdrawals from the policy, and any policy loans, are treated as a taxable event. This means you pay ordinary income tax on any gains when accessing any of the money inside a single pay life. This negates one of the most attractive features of a life insurance contract.
Tax Penalties
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Single pay life insurance is treated as a non-qualified retirement account for tax purposes. This means that you may not withdraw or borrow money from the contract prior to age 59 1/2. If you do, the IRS assesses a penalty of 10 percent on the amount you withdraw from the policy. This becomes problematic if you need to access the money prior to your retirement.
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