Many of the best life insurance companies offer limited pay policies. These limited pay whole life policies allow you to fund a permanent policy in a shorter amount of time. In the following article we will help shed some light on limited pay whole life pros and cons. But first, let’s get some basic definitions out of the way.
Limited Pay Whole Life Insurance Defined
Definition: A Limited pay whole life insurance policy has a set period in which you pay premiums into the policy, either for a number of years or to a specific age. Once you reach the target years or age, premiums are no longer required but the policy’s benefits lasts the insured’s entire life. Insurers offer limited pay policies in single premium, 7-Pay, 10 Pay, 15 Pay, 20 Pay and Life Paid up at age 65.
Limited pay policies are typically the best whole life insurance policies for building early high cash value. Normally they are participating policies, which means the insurance company pays an annual dividend to participating policyholders, which can be used to purchase paid-up additions, further enhancing the cash value growth of the policy.
Limited Pay Whole Life vs Term Life
The comparisons of whole life vs term life are not truly apples to apples. The products are very different and should be used in different circumstances, for different objectives.
Term life insurance lasts for a specified period of time. Once the term expires, the policy ends. You can choose to renew the policy, but it typically requires you pay a much higher premium that renews annually, each year going higher and higher.
With certain term insurance policies you can also convert your term life insurance to permanent life insurance coverage before the term life policy ends.
Limited pay life insurance is a life insurance contract between you (the owner/insured) and the carrier (the insurer), for the benefit of the beneficiary, that requires you to pay into the policy for a set period of time.
Once that period has been fulfilled, your policy is paid up and you do not have to make another insurance premium payment. However, your life insurance remains in force and will pay a lump sum death benefit to your beneficiary when you die.
Limited Pay Life Insurance Policies
Depending on the life insurance company, when considering limited pay whole life you will have several options to choose from. The different types of life insurance policies include:
Single Premium Whole Life
Single premium life offers permanent life insurance that is paid up in a onetime lump sum payment.
The pros of single premium is that you get leverage on your dollars and many of the benefits inherent in life insurance, such as a tax free death benefit.
7 Pay Whole Life
A 7 Pay Whole Life policy offers permanent death benefit coverage on a policy that is paid up in 7 years. The reason the number 7 is significant is because of the 7 pay test found in the internal revenue code determines whether a policy will be considered cash value life insurance or a modified endowment contract.
In other words, 7 Pay Whole Life is the shortest time frame you can choose to overfund your policy without it changing the nature of the policy.
10 Pay Whole Life Insurance
10 Pay Life provides permanent coverage that is paid up in 10 years. This is a very popular option, particularly for those who practice infinite banking with their policy.
You can choose a 10 Pay Whole Life Policy with a term rider to increase your death benefit coverage while you wait for the death benefit of the whole life policy to grow.
15 Pay Life
A 15 pay whole life policy provides coverage that lasts your entire life with premiums due for 15 years.
Some people opt for this policy over a 10 pay because the premiums are lower but you still get the advantage of a paid up policy in a relatively short period of time.
20 Pay Whole Life Policy
Another popular choice, 20 Pay Life provides lifetime coverage which is fully paid up in 20 years.
(Note: other top whole life companies offer similar accelerated underwriting on the different limited pay options).
30 Pay Life
30 Pay Life provides coverage that lasts your entire life with premiums due for 30 years. T
he pro with this policy is you stretch out the premiums for 30 years, resulting in more affordable whole life insurance in comparison to the other limited pay life options.
Life Paid Up at 65
A limited pay whole life policy to age 65 offers lifetime coverage which becomes a paid up policy at age 65. The number 65 is significant because it has been the common age of retirement since 1935.
The pro of paid up life insurance at 65 is that upon entering the retirement stage of life you no longer have to pay premiums, freeing up your cash for other pursuits or expenses.
In addition, your life insurance retirement plan is now fully funded, which can be used to help supplement your income in retirement.
Hypothetical 10 Pay Whole Life Policy
The following chart shows a sample whole life insurance cash value chart based on a policy that was taken out in 1980 by a 50 year old male. Dividend rates were higher back then so past performance is no guarantee of future performance.
In the following section we will address the pros and cons associated with a limited-pay life policy.
Limited Pay Whole Life Benefits
No more premiums. You pay into the policy for the required time and in return, you get a paid up policy with no more premiums due and all the benefits of cash value life insurance therein.
Long-term care: You can get a limited pay long term care life insurance policy. Many limited pay policies provide long-term care insurance rider and will pay a death benefit, long term care insurance benefit and cash surrender return of premium.
High Cash Value: limited pay whole life is a great way to supercharge your policy, giving you high cash value growth in the early years. For those looking to use life insurance as a personal bank, having your cash value grow quickly is a huge benefit.
Increased IRR: limited pay policies may also create a better internal rate of return (IRR), providing superior long-term growth in comparison to ordinary whole life that you pay premiums on until you die. One of the primary reasons is your policy is paid up and many of the fees associated with it are no longer taken, providing a higher return dollar for dollar.
Great for kids as well. Limited pay whole life insurance for children is a great way to provide for your kids into the future. You can pay into the policy for 10 or 20 years and your child will be able to reap the benefits for of whole life insurance for their entire life.
Drawbacks to Limited Pay Whole Life
Price. This is not cheap whole life insurance. Due to the rapid nature of paying on the policy for a limited time you will pay a higher premium than a policy that has its premium payment schedule stretched out to age 100.
However, you can always adjust the initial death benefit amount to lower your premiums. Over time, thanks to your guaranteed return plus potential dividends used to purchase paid up additions, your policy cash value and death benefit will continue to grow.
So, what that means is your policy will continue to work for you even after your initial payment period.
That way, even though it is more expensive than the cheaper whole life insurance to age 100, you will be paying into your policy for a shorter period of time, say for 10 years or to age 65. And this will free up your cash for other uses, rather than pay into your policy for another 30 or 40 years.
MEC. It is possible to MEC your policy with limited pay whole life. In particular, single premium whole life insurance does not meet the IRC requirements of cash value life insurance, so it is considered a modified endowment contract.
With limited pay policies, particularly those that are funded using paid up additions, it is important to keep an eye on the MEC level where your policy changes from life insurance to a modified endowment contract.
The good news is the insurance carrier can help you in determining how much you can safely contribute to your policy without your policy becoming a MEC. And if you go over the MEC limit, the insurance provider will alert you. Just make sure to open your mail!
Whole Life Insurance Benefits
In addition to the limited pay pros and cons above, some additional whole life insurance pros and cons will follow.
Whole life offers several benefits that need to be addressed in order to get a complete picture of why this asset is so valuable in any portfolio focused on wealth building.
We have written extensively on the best whole life insurance policies. But to recap here, whole life offers some fantastic benefits, which include guarantees such as:
Guaranteed Death Benefit
A whole life policy pays a guaranteed lump sum death benefit to your beneficiary. And with a properly designed policy, the death benefit GROWS over your lifetime, so when that inevitable day arrives, your policy has grown as you aged, allowing your beneficiary to receive a death benefit that has continued to grow over your lifetime.
Whole life premiums are guaranteed to never increase, i.e. the premium is fixed for the life of the policy. And with limited pay life, the premiums have an end date, but you continue to receive the pros associated with a whole life policy.
Guaranteed Cash Value
Participating life insurance cash value is guaranteed to grow year over year. The policy has a guaranteed 4% interest rate, plus life insurance dividends, increasing your total dividend rate to 5% or 6% presently.
Participating vs Non-Participating
There are two types of limited pay whole life policies to be aware of, participating and non-participating.
Non-participating whole life insurance does not pay dividend payments. We at I&E do not see much value in these whole life policies that do not pay dividends, as guaranteed universal life probably offers competitive rates for similar permanent death benefit coverage.
Instead, we typically recommend a participating whole life insurance policy, which offers policyholders the chance to participate in the company’s profits through dividends. Dividends are considered return of premium and are normally not included as taxable income.
Whole life insurance dividends can be used for:
- Purchasing additional paid up insurance
- Leaving with the company and earning interest
- Paying premium payments
- Receiving as a cash out payment
- Paying down outstanding interest or balance on an existing life insurance loan
Additional benefits of cash value life insurance
Whole life insurance is considered cash value life insurance for tax purposes. Cash value policies have a very favorable status under the internal revenue code, which offers incentives such as:
Cash value life insurance grows income tax free.
The Internal Revenue Code has incentivized cash value policies so that all gains in the cash account grow tax deferred. And you may never pay tax on those gains if you utilize the next benefit.
Policy loans are income tax free.
You can borrow against your policy’s cash value income tax free through life insurance loans. Anytime you need to tap into your cash value you can contact the carrier and request a policy loan, no questions asked. The loan is private and is not reported to credit agencies.
You can withdraw from your policy tax free.
Cash value withdrawals from your policy up to the basis are income tax free. Your basis is a number that takes into account your contributions into the policy. As long as you do not take out more than your basis, you can withdraw from your policy without having to pay income tax on the money.
The death benefit goes to your beneficiary income tax free.
The cash received from a lump sum death benefit payout to your beneficiary is not taxable to your beneficiary as income. If you or your beneficiary elect an option other than lump sum, any interest accrued on the death benefit will be taxed. However, the even in this scenario, the total death benefit is paid income tax free. It is only the interest on the death benefit that will be taxed as income.
The Best Limited Pay Whole Life Insurance
If we were to design the best limited pay life insurance policy it would need to take into account several factors that are specific to you. Since no two individuals are the same, no two policies are the same either.
With that in mind, there are some additional features that will help you put together the best limited pay whole life.
Limited Pay Life Insurance Features such as:
Paid Up Additions Rider:
Adding a paid up additions rider or paid-up additional insurance rider allows you to make additional monthly or annual payments into your policy to increase the death benefit and cash value. The additional cash value growth is further compounded through the accumulation of annual dividends paid by the carrier. Not all carriers offer dividends, so it is important you go with a company that offers a participating limited pay whole life insurance policy.
Participating Limited Pay Whole Life Insurance:
There are two types of whole life policies: participating and non-participating. Non-participating policies do not pay a dividend. Participating policies pay an annual dividend that can be used to purchase more paid-up life insurance, pay premiums, earn interest, or put cash in your pocket.
Non Direct Recognition vs Direct Recognition
A non-direct recognition company does not take into account an existing policy loan when determining the dividend rate to pay the policyholder. Direct recognition companies will adjust the dividend it pays to policyholders with an existing loan.
We typically prefer non direct recognition companies for those who plan on using their policy as a “safe bucket”, borrowing funds to purchase other income producing assets. An active policyholder who understands the velocity of money may find that non direct recognition companies offer a better environment to conduct their transactions from.
Limited pay life insurance is a great tool to provide all the benefits of whole life but without the ongoing premium requirement. You can use this policy to plan for your children’s future or your own retirement planning with life insurance. The best part is you won’t be on the hook for life insurance premium payments in retirement but you can use the policy benefits to help supplement your retirement income.