Permanent life insurance is a descriptive term for policies designed to remain in force for the entire life of the insured. Most permanent life insurance policies (such as whole life, variable life or universal life) also feature a cash value account, and this unique combination of a lifetime insurance benefit and tax-deferred accumulation can be a valuable asset in a comprehensive financial program. But making sure policyholders maximize the benefits from permanent life insurance requires thoughtful planning and on-going management.
Perhaps the most significant challenge in maintaining a permanent life insurance policy is continuing to pay the premiums. Leslie Scism, a Wall Street Journal reporter who covers personal finance issues, says, “Many buyers underestimate how difficult it can be to pay the premiums year after year, and they end up canceling their policy before they break even.” A 2016 study from the Society of Actuaries found that “more than a quarter of whole life policies are terminated in the first three years.” It seems redundant to state the obvious: To fully realize the benefits, a permanent life policy must remain in force.
Some critics say adhering to a premium schedule for a lifetime is not practical from a behavioral standpoint. This statement ignores the fact that many households make either rent or mortgage payments for their whole lives, month after month, year after year. The problem isn’t life insurance companies are asking too much of consumers; it could be that consumers don’t see their premium payments in the same light as their mortgages.
The Mortgage Analogy
Although the comparison isn’t perfect, buying a permanent life insurance policy is analogous to taking out a mortgage.
• An amortized payment (the monthly mortgage or insurance premium) secures the ownership of a much larger asset (the real estate or the insurance death benefit).
• In the early years, payments are proportionally weighted toward expenses (interest and cost of insurance) and only later tip toward accumulation (home equity and cash value). In the case of a permanent life insurance policy, it may take 15-20 years for cash values to exceed total premiums paid, depending on dividends1 paid or investment returns on the cash value.2
• At the end of the payment period the house is paid off, and the insurance policy is considered “paid up,” i.e., no additional premiums are required to keep the coverage in force.
• Today, the most common payment period for a mortgage is 30 years. For permanent life insurance policies, the most common payment period is for one’s whole life, i.e., from now until between ages 95 and 121.
• Consumers have some flexibility in determining the length of their mortgage, and the period of premium payments. Shorter terms result in higher periodic payments, but also accelerate home equity or cash value build-up.
In the right circumstances, policy owners may find that selecting a shorter premium period can be an effective approach to the challenge of keeping a permanent insurance policy in force for the long haul. Among the possibilities:
Single-premium life insurance. It is possible to obtain a permanent life insurance benefit and pay just one premium. Compared to a standard whole life policy with annual premiums, the single-payment amount will be significantly higher. But the cash value accumulation will also accrue more rapidly—in some policies, cash value may exceed the initial premium in the policy’s second or third year.
The cash values in single-premium policies are subject to slightly different tax treatment compared to most permanent life policies2, and depending on individual circumstances, this may be a disadvantage. However, individuals with substantial liquid assets may find it desirable to secure a permanent life insurance benefit through a simple one-time asset transfer.
10-pay and 20-pay life insurance. Instead of planning to pay premiums for a lifetime, most life insurance companies offer policies that can be paid up in shorter periods, such as 10 or 20 years. As with a mortgage, a shorter payment term means a larger outlay. But cash-value accumulation will be accelerated as well. An illustration of projected values for a 10-pay policy will typically show cash values not only exceeding premiums paid at the end of the 10-year period, but often providing a rate of return comparable to other conservative, guaranteed investment choices.
Unscheduled paid-up additions.3 This feature allows a policyholder to make irregular additional deposits to the policy, increasing both cash values and the total insurance benefit. Similar to extra principal payments that retire a mortgage early, unscheduled paid-up adds can be used to pay up a life insurance policy ahead of schedule. (Note: The IRS has strict guidelines on the tax treatment of cash values. Paying up a policy too fast might mean forfeiture of the tax advantages of cash values. Professional assistance is essential when using paid-up additions to shorten the period of payments.)
Selecting Your Payment Period
The best decisions about permanent life insurance are those that see these policies as long-term assets, ones that will typically be purchased through a series of payments over time. Choosing a shorter premium payment period may be one way to ensure your permanent life insurance purchase remains a long-term asset.
But even with longer “whole life” premium schedules, there are options for adjusting premium payments while keeping the policy in force. Once the policy accumulates cash value, it may be possible for policy owners to temporarily suspend payments. For cash-rich policies, it may be possible to suspend them for longer periods with no intention of resuming premiums at all.
When you combine an appreciation for the long-term value of permanent insurance with the different options for paying the premiums, you should recognize the truth of the statement that opened this article. Maximizing the benefits from permanent life insurance requires thoughtful planning and on-going management.
1. Dividends are not guaranteed, and are declared annually by the insurance company’s board of directors
2. Some whole life policies don’t have any cash values in years one or two. Whole life insurance should be considered for its long-term value. Early cash-value accumulation and early payment of dividends depend upon policy type and/or policy design, and cash-value accumulation is offset by insurance and company expenses. Consult with your Guardian representative and refer to your whole life insurance illustration for more information about your particular life insurance policy.
3. A Modified Endowment Contract (MEC) is a type of life insurance contract that is subject to first-in-first-out (FIFO) ordinary income tax treatment, similar to distributions from an annuity. The distribution is also subject to a 10 percent tax penalty on the gain portion of the policy if the owner is under age 59 1/2. The death benefit is generally income-tax free.
4. Paid-up Additions (PUA) are purchases of additional insurance (death benefit) that have a cash value. These purchases are made with dividends and/or a rider that allows the policyholder to pay an additional premium over and above the base premium. This creates the growth of death benefit and cash values in a participating whole life policy. Adding large amounts of paid-up additions may create a Modified Endowment Contract (MEC).
This article was prepared by an independent third party. Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS), 355 Lexington Avenue, 9 Fl., New York, NY 10017, 212-541-8800. Securities products/services and advisory services offered through PAS, a registered broker/dealer and investment adviser. Financial Representative, The Guardian Life Insurance Company of America (Guardian), New York, NY. PAS is an indirect, wholly owned subsidiary of Guardian. Wealth Advisory Group LLC is not an affiliate or subsidiary of PAS or Guardian.
PAS is a member FINRA, SIPC.
Neither Guardian, PAS, Wealth Advisory Group, their affiliates/subsidiaries, nor their representatives render tax or legal advice. Please consult your own independent CPA/accountant/tax adviser and/or your attorney for advice concerning your particular circumstances.
2018-64968 Exp. 7/2020
Submitted by Elozor Preil