While most Whole Life Policies require premium payments that last to either 100 or 120 years of age for the insured (essentially, till the end of your life), you may have heard that there are other options for Whole Life Insurance: Limited Pay Whole Life Insurance.
In this article, we’ll go over all the aspects of a Limited Pay Whole Life Insurance policy and how this type of policy is different from other life insurance products.
Hopefully, by the end of this article, you will be able to make an informed decision about the type of policy that you’re looking to buy — with the best outcome for you and your loved ones.
Limited pay life insurance is a type of whole life insurance with a much shorter guaranteed payment period than a usual whole life policy. There are several types of limited pay life insurance policies all with differing guaranteed premium payment periods, but despite these differences, all limited pay policies work on the same principles — limited payment.
This basically means a shorter payment period than the age of 100 or 120. This type of insurance is just a whole life policy with a much shorter required payment period (the number of years in which you pay your yearly fees or annuities differs — and there are several options).
Insurance agents and companies also fairly commonly call limited pay policies “short pay policies”.
Now let’s take a deep dive and see what Limited Pay Whole Life policies are really made of, who they’re made FOR, and what benefits you can gain from them.
To clarify things even more, let’s break down Limited Pay Whole Life into the simplest of terms:
Limited pay life insurance is a life insurance contract between the insured (you) and the carrier (insurance company), for the benefit of the beneficiary (your heirs).
Once the period of payments has been fulfilled, your policy is paid up and you do not have to make any more insurance premium payments.
However, your life insurance remains “in force” and will pay your beneficiary a “lump sum” death benefit (all of the money at once) when you die.
Not that difficult, right?
Now let’s look at the number of years most insurers offer.
The most common Limited Pay Whole Life options are:
- 10 pay
- 20 pay
- Paid Until Age 65
As you probably assume, the numbers in these options represent the number of years you pay your annual premiums to the insurance company, which then accumulates over time.
In practical terms, it’s good to know that fewer years most often means a higher annual premium.
For example, a $500 000 10 years limited pay whole life insurance policy will cost more than a $500 000 20 year policy.
On the other hand, a shorter pay period means that you will accumulate cash value much faster (in most cases).
The most common way of differentiating between types of Limited Pay Whole Life Insurance Policies is by the number of years till which they are payable. Different payment terms make most of the difference here.
Here are some other things you need to know (and discuss with your insurer):
- You can pay your life insurance premiums annually, semi-annually, or monthly
- Most limited pay whole life insurance policies have a guaranteed cash value that grows tax-deferred
- Depending on the company, your limited pay whole life insurance policy may be eligible to earn annual dividends
- Just the same as other life insurance policies, the death benefit typically passes on to your beneficiary tax-free
Remember: You can save money on your limited pay whole life insurance policy by purchasing it when you are young and healthy.
Someone beginning their search for limited pay policies usually looks for a difference between whole life and term life insurance. Let’s clarify that before moving on.
Term life insurance lasts for a specified period of time. Once the term expires, the policy ends — you are no longer insured.
Term policies can be renewed, but this typically requires you to pay a much higher premium (that renews annually) and gets higher and higher each year.
Usually, you can’t use this type of policy as a wealth-building or a tax-planning strategy, so keep this in mind in case this interferes with your financial goals.
With certain term insurance policies, you can also convert your term life insurance to permanent life insurance coverage before the term life policy ends.
Whole Life Insurance is a form of permanent life insurance.
It never expires as long as you keep making your premium payments. It also provides cash value in addition to the death benefit, unlike term life insurance.
There is also Modified Whole Life Insurance (aka Modified Premium Whole Life insurance, Graded Life Insurance, or Return of Premium Whole Life Insurance).
This is a type of permanent life insurance that offers a much lower premium for the first few policy years in exchange for a higher premium after an introductory period.
“Modified” whole life insurance has an initial “modified” level of coverage that typically lasts a specific number of years at the beginning of the insurance policy.
Depending on your goals, you may need Whole Life or Term Life, but most likely not BOTH. Just keep in mind that these are different insurance products and should be used for different goals.
In this article, we’ll focus on Whole Life Insurance Policies.
There are two types of limited pay whole life policy types: participating and non-participating types.
A participating whole life insurance policy offers policyholders the chance to participate in the company’s profits through dividends. Annual dividends are considered returns of premium and are normally not included as taxable income.
Whole life insurance annual dividends can be used for:
- Purchasing additional insurance (paid-up additions)
- Leaving with the company and earning interest
- Paying premium payments
- Receiving a cash-out payment
- Paying down outstanding interest or balance on an existing life insurance loan
Non-participating whole life insurance does not pay dividends. This type of policy is generally not the most common choice.
As we mentioned above, when considering limited pay whole life you will have different options to choose from (there will be differences depending on the life insurance company). The most common limited pay options are:
Single premium life insurance offers permanent coverage that you pay all at once.
The biggest advantage of a single premium whole life is that you get leverage on your money and a tax-free death benefit.
The downside here is that this type of policy is considered a modified endowment contract and you lose some of the tax advantages of cash value life insurance (more on that later).
A 7 Pay Whole Life policy offers permanent death benefit coverage and it is paid up in 7 years.
The “7 pay test” in the internal revenue code determines whether a policy will be considered cash value life insurance or a modified endowment contract.
This means that 7 Pay Whole Life is the shortest time frame you can choose to overfund your policy without it changing the nature of the policy and being taxed for it.
10 Pay Life provides permanent coverage and it’s paid up in 10 years. This option is particularly popular with 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 waiting for the death benefit of the whole life policy to grow over the years.
Limited pay life insurance is for an individual who owns a whole life insurance policy but chooses to pay for the total cost of their premiums for a limited number of years. With the limited pay life insurance option, you pay premiums in the first 10, 15, or 20 years of ownership, but the benefits last a lifetime.
Permanent life insurance requires premium payment for your entire life. If you choose limited pay whole life option, it must be determined at the initial purchase of the policy.
This payment option is mostly for those who purchased permanent life insurance later in life and want to stop funding their policy but still receive the cash value.
There is another very common limited pay policy: A Universal Life Policy or UL.
A Universal Life policy is a type of permanent policy that builds cash value and has level premiums.
There are many different kinds of UL policies, so you have to understand them better before purchasing. Contact your agent.
The most important thing to know about UL policies is that you have to use certain assumptions to make the policy limited pay. Of course, you can rest assured, because any good agent that knows what they are doing will be able to design a limited pay universal life policy.
If designed properly your life insurance premiums will stop, and you will keep your policy benefits forever. Just make sure to look at the guaranteed assumptions on a UL so you can understand what you are buying.
Currently, Index Universal Life or IUL is a very popular policy type.
While limited pay life insurance most commonly refers to whole life insurance, there is a special type of universal life insurance that also meets the definition of limited pay life insurance. It’s called Guaranteed Universal Life Insurance (GUL).
Here’s how a GUL works: Once the policy owner meets the required number of premium payments, the policy cannot be canceled by anyone other than the policyholder.
Because limited pay policies have fewer required premiums to reach paid-up status, they do, however, require larger premiums each year versus regular whole life insurance policies.
On the other hand, the best part about this is that you still stop paying premiums after a certain age, so you can use the policy benefits to supplement your retirement income.
Whole life offers several benefits. Knowing them will paint a more accurate picture of why Whole Life is so valuable if you’re focused on building wealth.
Whole life premiums are guaranteed to never increase — the premium is fixed for the life of the policy. And with limited pay life, the life insurance premiums have an end date, but you continue to receive the pros associated with a whole life policy even after you’ve paid them off.
A whole life policy pays a guaranteed lump sum death benefit to your beneficiary. The death benefit GROWS over your lifetime (with a properly designed policy) and this allows your beneficiary to receive a larger death benefit (that continues to grow over your lifetime, until your death).
Participating insurance cash value WILL build up year for year. This type of policy has a guaranteed 4 percent interest rate, plus life insurance dividends, which makes for a total dividend rate of 5 or 6 percent.
You may be wondering why more people don’t have limited pay whole life insurance if there are so many benefits? Well, no type of insurance is for everyone. Here are the downsides:
Despite all the benefits, keep in mind that you’re much better off looking into other types of life insurance if you’re looking for low premiums.
Limited pay whole life insurance is not cheap. You should expect a more expensive annual payment than you would with a traditional whole life policy. This is due to the fact that you’re paying premiums for a predetermined period of time – not the rest of your life.
One of the ways around this is to lower your death benefit, which will allow you to pay a smaller premium. However, thanks to your cash value growth and potential dividends, your policy will still grow over the years.
You could also consider longer pay periods to lower your whole life rates.
It is possible to MEC your policy with limited pay whole life. This is particularly the case with single premium whole life insurance policies.
Since they do not meet the IRC requirements of cash value life insurance, they’re considered a Modified Endowment Contract, which means:
1. You exceed legal tax limits, therefore:
2. The MEC status removes the tax benefits of withdrawals you can make from the policy, meaning:
3. Your policy ceases to be tax-free.
That’s why with limited pay policies (particularly paid-up additions funded policies), it is important to prevent your policy to change from life insurance to a modified endowment contract.
Your insurance agent can help you determine how much you can safely contribute to your policy, without it becoming a MEC.
Whole life insurance is considered cash value life insurance, for tax purposes. Cash value life insurance policies have a favorable status under the internal revenue code, and this offers different incentives, such as:
- Cash-value Life Insurance Grows Without And Income Tax
All gains in the cash account grow tax-deferred in a Cash-value Life Insurance Policy. And you may never pay tax on those gains if you utilize the next benefit.
- Policy Loans Are Income Tax-Free
You can borrow through life insurance loans against your policy’s cash value income-tax free. 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
Your basis is a number that takes into account your contributions to the policy. As long as you do not take out more than your basis, you can withdraw from your policy without any income tax on that 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 considered taxable income to your beneficiary.
If you or your beneficiary choose an option different than a lump sum, any interest received on the death benefit WILL be taxed.
However, 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 considered taxable income, and get taxed.
Policyholders often purchase a whole life policy later in life.
If you are looking to receive an income during retirement through your policy’s cash value or dividend payment, then limited pay life insurance is an excellent option to prevent having an obligation to pay premiums during retirement.
If an individual is purchasing a policy at a younger age, limited pay life insurance is something that should generally be avoided.
This is due to the fact that a younger person has time on their side to assist in compounding the interest earned from the cash value. When there are no limitations to what you can pay into your policy, it will just keep growing — which means more money.
Policy owners can access their money through a policy loan, while the cash value associated with their initial policy is still earning interest. This is what makes whole life policies invaluable.
If we were to design the best limited pay life insurance policy we would need to take into account several factors that are specific for every policyholder.
Because no two individuals are the same, no two policies are the same either.
Your insurability is based on your personal Life Insurance Quote.
Here’s a breakdown of two life insurance policies with their annual life insurance premiums, to give you some perspective on the actual underwriting process and common insurance companies’ risk assessment
Note: These are just examples. The numbers differ in practice.
The table below is a 10 Pay Whole Life Insurance Quotes are from an A+ rated carrier for a preferred plus male. Annual Rates are for informational purposes only and must be qualified for.
The following example whole life insurance quotes are based on a preferred plus male wanting ordinary whole life insurance to age 100 with an A- rated insurance company or better.
Keep in mind: the numbers in both examples are general. Each individual is different and qualifies for his policy personally.
Regardless of whether or not a whole life policy is limited pay, the cash value benefits still exist. Cash value is crucial because it helps any individual receive liquidity at any time they choose.
The main things to keep in mind about Limited Pay Whole Life Insurance Are:
- Limited — meaning you’re not required to pay a premium until your death. Once you pay your policy in full, you no longer make payments and you keep your coverage.
- A high cash value growth type of policy. With a limited pay whole life, you achieve high cash value growth early on. Their growth rates are second to none.
- A good way to care for your family in the future. You can use this type of insurance to provide for your loved ones. Once you’re done paying your life insurance premiums, your policy remains intact and your heirs can take advantage of it.
You Should Keep In Mind That:
- It can be pricey — the premiums are often large, and therefore best suited for higher net worth individuals.
- It can become MEC — single premium whole life insurance policies, in particular, can be considered a Modified Endowment Contract, and your policy will cease to be tax-free if it reaches this status.