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What Is Limited Pay Life Insurance?

Limited pay life insurance is a type of whole life insurance policy that is structured to only owe premiums for a set number of years. In other words, rather than paying your insurance premiums in perpetuity, you agree to pay them in full over a pre-specified time. With the limited pay life insurance option, you pay premiums in the early years of ownership, but the benefits last a lifetime.

As with any type of life insurance, a limited pay policy has its pros and cons. Deciding if it’s right for you depends on your budget and financial goals. In this article, we’ll explain how limited pay life insurance premiums differ from regular whole life insurance premiums and types of limited pay policies. First, let’s look at whole life insurance.

HOW WHOLE LIFE INSURANCE PREMIUMS WORK

Whole life insurance is a form of permanent life insurance, meaning you are guaranteed coverage for life and your beneficiary is guaranteed a death benefit, provided your premiums are paid. Normally, you pay these premiums monthly, quarterly, semi-annually, or annually for your entire lifetime. 

When you pay your premium, a portion goes toward paying for your death benefit and any associated fees, and a portion is reflected in your policy’s built-in savings account, called cash value. You can access your policy’s cash value at any time by making a withdrawal or taking out a policy loan. These actions affect your death benefit in one of two ways: Withdrawals may lower your death benefit. Policy loans may be deducted from your death benefit if they’re not repaid during your lifetime.

Most types of permanent life insurance benefits work this way. But not all permanent life insurance premiums work the same. Whole life insurance premiums are level, meaning they won’t go up. Some policies, like universal or variable life insurance, allow the policyholder to adjust their policy amount. This can be both an advantage and a disadvantage. 

On the one hand, you have flexibility if you run into financial hardship. On the other hand, decreasing your premium can reduce your death benefit or deplete your cash value to the point that your policy lapses and you lose coverage. Plus, you’re not the only one who gets to adjust your premium with a universal or variable life insurance policy—your insurance company can decide to raise premiums at any time.

The benefit to having level premiums is that they are easy to plan for, as they’ll never change. This is helpful when it comes to building your budget or saving for retirement. Level premiums are a fixed expense you can count on. 

Another benefit of level premiums is that the growth of your whole life insurance policy can—and often does—offset the premiums due. This means that eventually you can use your policy’s growth (cash value and/or dividends) to pay your premium. In other words, your policy may eventually pay for itself.

HOW LIMITED PAY LIFE INSURANCE PREMIUMS WORK

With a limited pay life insurance policy, the policyholder opts out of allowing their policy’s growth to eventually pay for their premiums. Instead, you pay for the cost of the policy in its entirety over time. Your policy still grows wealth in the form of cash value and potential dividends, but you elect NOT to put those earnings toward premium payments.

You can choose the timeframe in which you’d like to pay for your policy, usually 10, 15, or 20 years. Alternatively, you can choose to stop paying premiums at a certain age, like 65, and the cost of the policy premiums are adjusted accordingly. And you can choose if you want to pay your premiums monthly, quarterly, semi-annually, or annually. You may also have the option of paying just one lump-sum payment. However, you must decide BEFORE you purchase your whole life insurance policy if you’d like it to be structured for limited pay. It’s not something you can change once the policy is in force.

Limited pay life insurance can be especially beneficial to individuals who purchase permanent life insurance later in life and want to stop funding their policy, but still receive the guaranteed rate of return on their cash value and non-guaranteed dividends. This is especially true if you are looking to receive an income during your retirement through your policy’s cash value or dividend payment without having to worry about funding premiums when you’re no longer working.

LIFE INSURANCE PAYMENT STRUCTURES

If you’re thinking about purchasing a whole life insurance policy, it’s important to know the pros and cons of the various types of payment structures that may be available to you. Keep in mind policy offerings may vary by state and insurer.

Standard Whole Life Insurance

Many standard whole life insurance policies provide coverage to age 121. In theory, this means you’ll owe premiums until age 121. But keep in mind that once you pass away, your policy terminates, regardless of how much you’ve paid into it. Your beneficiary is guaranteed to get the tax-free death benefit in full, minus any outstanding policy loans. From a cost perspective, paying into a policy over a long period of time has the primary advantage of offering the least expensive premiums compared to limited pay whole life policies.

Single Pay Whole Life Insurance

Single pay or single premium life insurance is paid in one lump sum. The benefit of paying for your insurance all at once is that you supercharge your policy for growth, optimizing it to increase cash value and potential dividends. Unfortunately, paying for your insurance with one single payment is looked upon unfavorably by the IRS. In fact, the IRS doesn’t consider this kind of purchase life insurance—they call it a modified endowment contract, or MEC. 

For individuals with large estates looking to pass assets on to their heirs, a one-time MEC purchase may have its benefits. But if your primary goal is to use your insurance policy to grow wealth and have it function as your own private banking system, a single pay policy isn’t right for you. MECs aren’t eligible for many of the tax advantages associated with whole life insurance. Here’s how the two differ:

Taxes & Whole Life Insurance 

  • Tax-free growth of interest and dividends
  • Growth of cash value can be used tax-free
  • Tax-free policy loans
  • Tax-free retirement income
  • Income tax-free death benefit
  • Estate tax-free death benefit

Taxes & Modified Endowment Contracts

  • Tax-deferred growth of interest and dividends
  • Growth of cash value is taxed when used
  • Policy loans are taxed
  • Retirement income is taxed
  • Income tax-free death benefit
  • Estate tax-free death benefit

7-Pay Whole Life Insurance Policy

A 7-pay whole life insurance policy, sometimes called overfunded life insurance, helps optimize growth like a single pay policy but receives the tax benefits of standard whole life insurance. It is structured so that the policy is paid up in 7 years and meets minimum requirements set by the IRS to be considered whole life insurance with cash value vs. a modified endowment contract.

10-, 15-, 20-, 25-, 30-Pay Whole Life Insurance Policies

Incremental limited pay life insurance policies between 10 and 30 years can be customized depending on when you want to stop paying into your policy. The shorter the pay period, the more expensive your premiums will be. However, the quicker you pay up your policy the faster you optimize growth in your cash value and dividends. 

Whole Life Insurance Paid Up to 65

For individuals who don’t want to worry about paying insurance premiums in retirement or who want to use their policy’s cash value for retirement income, it’s common to purchase limited pay life insurance that’s paid up at age 65. Depending on your insurer, you may be able to customize your policy to coincide with your actual retirement age, whether it’s 67, 72 or early retirement. Annual premiums will depend on how old you are when you purchase your policy and your health. The earlier you buy whole life insurance, the smaller your premiums will be if you choose a policy designed to be paid up when you retire. 

Limited Pay Life Insurance for Children

Parents want to make sure their children are financially secure, and limited pay life insurance for children can be a great way to do that. Children can be insured at just a couple weeks old, and barring any health issues, their insurance premiums are extremely favorable compared to adults. Because whole life insurance premiums remain level for life, you not only lock in a great rate, but it may be easier to pay off their policies in a limited pay structure before they reach adulthood. 

Imagine your child never having to worry about insurance premiums but getting the benefit of accumulated cash value through a guaranteed rate of return and potential dividends. 

THE PAID-UP ADDITIONS RIDER

If you’re young and ready to purchase a policy, 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 can just keep growing.

When you purchase a whole life policy, regardless of whether or not it’s a limited pay policy or a standard policy, one of the main benefits is the cash value, which can be used as a tool or strategy to finance other performing assets. The best way to maximize your policy’s cash benefit is to add a paid-up additions rider. Insurance riders are supplemental insurance available for a fee (some are free) that increase the benefits of your policy, particularly living benefits that you can enjoy during your lifetime.

Paid-up additions can be structured in a variety of ways:

  • Accelerated 7-pay PUA for fastest growth and highest earnings
  • Enhanced PUA over a longer number of years

Even if you don’t opt for a limited pay life insurance policy, it’s worth considering limited pay paid-up additions with a standard whole life insurance policy to help optimize cash value, potential dividends, and your death benefit. In fact, you can even use your dividends to purchase paid-up additions (which then earn their own dividends). 

If you opt for a PUA rider at the same time you open your whole life insurance policy, your dividends will need to accumulate, so they will go toward your paid-up additions in later years. If you’re eligible to add a PUA rider to an existing policy, your existing dividends can be used to purchase your paid up additions.

Click here to see illustrations of real policies outlining accelerated 7-pay PUA and enhanced PUA examples: https://paradigmlife.net/blog/paid-additions-pua-life-insurance/

BUYING A LIMITED PAY LIFE INSURANCE POLICY

Choosing the right life insurance policy is a key part of building a financial foundation, accomplishing your financial goals, and leaving a financial legacy for your family. It’s also a big commitment. How do you make sure you’re buying a policy that will meet your needs without overpaying?

The Wealth Strategists at Paradigm Life have helped thousands of clients in all 50 states and Canada structure life insurance policies that help them grow and protect wealth while also customizing policies to work with a variety of budgets. We work with the nation’s top-rated insurance companies to find your perfect policy. What’s more, consultations are always free. 

Request a free virtual consultation to learn more about limited pay life insurance and paid-up additions with whole life insurance. Whether you’re looking for more income in retirement, trying to diversify your financial portfolio away from Wall Street, or simply provide your loved ones, your goals are our goals and we’re with you every step of the way.

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