You’ve probably heard your mother say a million times, “Don’t throw that out; one day, it will come back in style.” And somehow, some way, her words always ring true, and you find yourself looking at an item in the back of your closet that once again has become the hottest thing on the runway. Well, what’s true for fashion is valid for life insurance.
Single-Premium Whole Life (SPWL) policies are coming back in vogue as a way for aging Baby Boomers to maintain asset liquidity while protecting their principal and efficiently planning concerning taxes.
As the name implies, with an SPWL policy, you pay the entire premium due for the duration of the policy in one payment. Generally, any policy with a cash value feature can be purchased with a single premium. These policies fell out of favor back in 1988 with the passage of the Technical and Miscellaneous Revenue Act (TAMRA) because the valuation method in which income was realized was changed to a formula known as “Last In, First Out” (LIFO). In other words, every dollar withdrawn from the policy’s cash value will be taxable until you exceed the original basis.
However, despite this, SPWL has several tangible benefits when used in estate planning because it allows you to maximize the money left to heirs while maintaining control over that money during your lifetime. The first advantage of this policy is that the cash value snowballs because the procedure is fully funded from the beginning. Your cash value builds on a tax-deferred basis, and you will only pay tax on earnings if you withdraw from the policy. Your named beneficiaries will receive death benefits free of income tax. This is a significant benefit because it provides your heirs timely access to the estate you have provided them without all of the legal costs associated with probate.
In addition, you never lose control of the money that comprises that estate. You can access cash for living expenses by switching your dividend option from increasing death benefits to cash payments. Even though this could be considered a partial surrender, you will not incur fees because today’s SPWL policies do not have surrender charges.
You can also use the cash value to borrow against the policy. Generally, a policy owner can borrow up to 90% of the policy’s cash surrender value. This will, of course, reduce both the policy’s cash surrender value and the death benefit. However, you can repay the loan and reinstate the original death benefit at any time.
Remember that charges can result from withdrawals or loans from your SPWL policies because they are usually considered modified endowment contracts under TAMRA. This translates into a 10% IRS penalty on all gains withdrawn or borrowed before age 59 1/2. Of course, you will also have to pay income tax on those earnings.