Definition and examples of single premium deferred life insurance
How single premium deferred life insurance works
Advantages and disadvantages of single premium deferred life insurance
Alternatives to single premium deferred life insurance
Definition and examples of single premium deferred life insurance
Single premium deferred life insurance is a financial product that guarantees a steady stream of payments over a specified period, regardless of market performance. Single premium deferred life insurance must be created with just one lump sum payment. This large amount is the premium that is paid upfront. The minimum investment in single premium deferred life insurance varies from around $5,000 to millions of dollars, depending on the type of insurance.
Abbreviation: SPDA
Single premium deferred life insurance is popular among conservative investors who want to ensure income in retirement regardless of wider market performance. It is easier to set up when you have one significant amount to invest. You may start single premium deferred life insurance after you:
- Receive an inheritance
- Amass a large balance in a 401(k) account after leaving a job
- Sell a business
How single premium deferred life insurance works
Deferred life insurance is insurance that does not start paying out immediately. First, you fund the account and then at a time of your choosing, you begin to receive payments.
Because deferred life insurance is often tax-deferred, it comes with the same rules that apply to other retirement accounts that receive this preferred tax treatment. You must wait until you are at least 59 and a half years old before withdrawing funds, or you will incur a 10% penalty in addition to the regular income tax that comes with the withdrawal.
Deferred life insurance also comes with guarantees. Generally, even if markets have a bad year, your account will not lose money.
With single premium deferred life insurance, the least you can receive is something, not nothing. There are no negative returns. The price you pay for this guarantee is the loss of some opportunities. If financial markets have an incredible year, your gains may be capped at a certain amount, and the rest will be kept by the insurance company, ensuring there is some money to pay out in a bad year.
This type of insurance carries surrender penalties that encourage you to keep the money invested for a long time. If you need to withdraw money during the first ten years, or any period specified by the insurance company in the contract, you will incur surrender fees.
Some insurance companies may allow a free withdrawal of a certain amount and/or reduce the surrender fees each year until they are completely gone. At that point, you won’t have to pay a fee if you withdraw your funds.
Advantages and disadvantages of single premium deferred life insurance
Advantages
- Income guarantee: Insurance provides regular payments during retirement, offering a stable and reliable income source that can greatly facilitate retirement planning.
- Reduced market risk: You won’t have to worry about financial markets crashing shortly before retirement or unexpected risks that could make it impossible to realize gains in other retirement investments.
- Simplified tax planning: Since your income will be reliable and regular, you can plan your tax strategy for retirement in advance, including how to utilize your other investments and retirement funds.
Disadvantages
- Limited wealth creation: Deferred life insurance is similar to an insurance product. You pay a monthly premium to protect against the risk of loss, but it does not build wealth. Instead, you will need to rely on investment products to build your wealth.
- Fees
- Expensive: Insurance comes with high fees compared to some other investment products.
- Large upfront investment: Single premium deferred life insurance can only be accessed if you have a large amount of money to pay the initial premium. Depending on the size of the premium and your life expectancy, the payments you receive may never equal the initial premium.
- Illiquidity: Due to early withdrawal fees and surrender charges, single premium deferred life insurance does not have liquidity. You cannot easily access your money if you suddenly need cash.
Alternatives to Single Premium Deferred Life Insurance
If single premium deferred life insurance is not the right choice for you, there are other insurances you can invest in. They are often used to ensure a monthly income flow regardless of market conditions. Consider insurance as retirement.
Most insurances will come with monthly payments instead of a single premium. The returns from this type of insurance grow tax-deferred until you start taking distributions. While paying into this type of insurance, the insurance company will invest the money. Depending on the contract, you may have the ability to influence how those funds are invested.
An alternative for investors who have a large amount is an IRA with the appropriate risk profile.
Summary:
Single premium deferred life insurance is created through just one payment and provides a guaranteed income stream thereafter. Single premium deferred life insurance may have high fee structures and a large initial premium that can make it inaccessible to some investors. Single premium deferred life insurance is a strong option for conservative investors and can help them plan for future tax implications.
Source: https://www.thebalancemoney.com/what-is-a-single-premium-deferred-annuity-4163936
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