Table of Contents
Table of Contents
- A limited pay life policy is a special kind of whole life policy in which you receive permanent insurance coverage for the rest of your life while only paying premiums for a limited period of time.
- 7 pay life insurance, 10 pay life insurance, 15 pay life insurance, and 20 pay life insurance are the most common types of limited pay life policies.
- Having a limited pay life policy offers you numerous benefits, including guaranteed level premiums, faster cash value growth on a tax-deferred basis, a flexible source of funding, and predictable costs.
- Downsides to having a limited pay life policy are higher premiums, the risk of becoming a modified endowment contract (MEC), and the lost opportunity cost of investing your money elsewhere.
- You cannot convert an existing whole life insurance policy into a limited pay life insurance policy.
Definition of a Limited Pay Life Policy
The defining element of this type of whole life insurance is “limited pay.” A limited pay life policy is a special type of permanent life insurance in which you make a limited number of premium payments over a specified number of years to your insurer in exchange for a lifetime of insurance coverage.
Premium payments end after a number of years (usually in fixed periods of 7, 10, 15, or 20 years), but your coverage continues beyond your last premium payment until the end of your life. This differs from term life insurance, in which your insurance coverage ends when you stop making your premium payments at the end of the term you select (usually 10, 15, 20 or 30 years).
What Is an Example of a Limited Pay Life Policy?
One example of a limited pay life policy is 10 pay premium life insurance. If you are currently 45 years old and purchase a 10 pay premium life insurance policy, you will be required to make premium payments on this permanent insurance policy for a period of 10 years until you are 55 years old. After 10 years, you no longer need to make any premium payments; however, you coverage is permanent and will last the rest of your life.
How Does a Limited Pay Life Policy Work?
The biggest decision you have to make with a limited pay life policy, other than how much coverage you need, is the fixed period of time you want to select for paying your premiums. Typically, you can choose a period of 7, 10, 15, or 20 years to pay all of your premiums for a limited pay life policy.
For example, if you choose a 15 pay insurance policy at 30 years old, you will pay your premiums during the first 15 years of the policy. Even if you live to be 85, you will be finished paying your premiums by the time you turn 45, with 40 more years to live. If you had chosen a traditional whole life policy, you would be paying over 55 years.
Each limited pay life policy payment will be higher than what you would pay for an ordinary whole life policy because the lifetime premium payments are condensed into a shorter period.
As with a traditional whole life insurance, you may choose to pay your premiums for a limited pay life policy on a monthly, quarterly, semi-annual or annual basis.
One other important thing to note: If you have an existing whole life insurance policy, it cannot be converted into a limited pay life policy once it is in force. When you initially purchase a life insurance policy, you must decide whether you specifically want a limited pay life policy.
How Is a Limited Pay Life Policy Different From a Whole Life Policy?
If you have a whole life policy, you are required to make premium payments for the duration of your lifetime. If you have a limited pay life policy, you are only required to make premium payments for a fixed period, usually 7, 10, 15, or 20 years. When this fixed period ends, you no longer need to make premium payments, but your coverage remains in effect for the rest of your life.
How Long Does Coverage Last on a Limited Pay Life Policy?
Because a limited pay life policy is a special type of permanent life insurance, your coverage lasts for the duration of your entire life, just like a whole life insurance policy. While your premium payments end after a fixed amount of time, your coverage does not.
Types of Limited Pay Life Insurance Policies
The most common types of limited pay life insurance policies are:
- 7 Pay Premium Life Insurance — With a 7 pay premium life insurance policy, you agree to make all of your premium payments within a period of seven years. In return, you will have permanent life insurance coverage for the remainder of your life. Because a lifetime of premiums are condensed into only seven years, this limited pay life policy will be the most expensive of these four options.
- 10 Pay Premium Life Insurance — By purchasing a 10 pay premium life insurance policy, you commit to paying all of your premiums during the first 10 years of the policy. Given the same coverage amount, this type of limited pay life insurance will be less expensive than a 7 pay premium life policy but more expensive than a 15 pay or 20 pay premium pay life policy.
- 15 Pay Premium Life Insurance — Just like the above policies, a 15 pay premium life insurance involves a fixed duration of premium payments — this time over 15 years. Again because of the shortened time period to make an equivalent total payment of a lifetime of premium costs, a 15 pay premium life policy will be less expensive than either a 7 pay or 10 pay policy but more expensive than a 20 pay policy.
- 20 Pay Premium Life Insurance — If you select a 20 pay premium life insurance policy, you agree to pay all of your premiums within a period of 20 years. Because this specific policy has the longest time frame, it will be the least expensive of the four policies described here (assuming the same coverage amount, one again).
What Does a Limited Pay Life Policy Cost?
Different insurance companies will offer you their own separate quotes for coverage for a limited pay life policy. However, in general, the cost of a limited pay life policy depends on several factors:
- The number of years you select to pay your premiums — The shorter the pay period you select, the higher your premiums will be. For example, premiums for 7 pay life insurance will be more expensive than premiums for 20 pay life insurance (at the same coverage amount) because you have 13 fewer years to pay for the policy's total cost.
- The amount of coverage you need — The higher your coverage amount, the more expensive your policy will be. For example, a $200,000 limited pay policy will cost you more than one for $100,000.
- Your age, gender, and overall health when you purchase the policy — The younger and healthier you are when you take out the policy, the lower your cost will be in general. Insurers also price policies differently for men and women, given their projected life expectancies. For 2021, the current life expectancy at birth for U.S. women is 79.1 years, while current life expectancy at birth for U.S. men is 73.2 years — for a disparity in life expectancy between men and women of 5.9 years.1 Given that women are expected to live longer than men, their coverage tends to be less because insurers can spread out the risk of insuring women over a longer period of time.
What Are the Benefits of a Limited Pay Life Policy?
The benefits of a limited pay life policy include:
- Guaranteed Level Premiums for a Fixed Period — The premiums you pay remain the same for the entire limited period of time that you choose for your limited pay life policy.
- Guaranteed Lifetime Insurance Coverage — Like other whole life insurance policies, your coverage is guaranteed to last for your entire life with a limited pay life policy, as long as you continue to pay your premiums on time to keep the policy in force.
- Cash Value That Grows Tax-Deferred — Because you are paying higher premiums, your policy has more money in it, so your cash value can grow at a more rapid rate. Just like other whole life policies, your cash value in a limited pay life policy grows tax-deferred.
- Policy Dividends — Although not guaranteed, your limited pay life policy may pay policy dividends, which can provide you with an additional source of income.
- Living Benefits — A limited pay life insurance policy with living benefits may appeal to you. Depending on your policy, you may be able to use a portion of the death benefit for medical expenses while you are still alive if you have a qualifying medical condition or terminal or chronic illness, as defined in your insurance contract.
- No Premium Payments During Retirement — A key advantage of a limited pay life policy is that it allows you to pay all your premiums in the time frame you choose. So if you don’t want to be paying life insurance premiums during your retirement, a limited pay life policy may be an attractive option to ensure you finish paying your premiums before you decide to retire.
- Income During Retirement — You can access the cash value of your limited pay life policy through policy loans or withdrawals during retirement to supplement your income.
Are There Any Tax Benefits With a Limited Pay Life Policy?
There are some important tax benefits with a limited pay life policy. First, a limited pay life policy accumulates cash value over time on a tax-deferred basis (just like a whole life insurance policy). You may borrow against this cash value through policy loans and withdrawals to help pay for a major purchase (like a new car) or various expenses in a life emergency, such as a job loss.
Keep in mind that unpaid loans may reduce the death benefit amount. Second, the death benefit that your beneficiary receives from a limited pay life policy is typically tax-free because the IRS generally does not charge income tax on life insurance death benefits.
What Are the Potential Drawbacks of a Limited Pay Life Policy?
Limited pay life policies may not be ideal for everyone. Here are some potential drawbacks to consider:
- Higher Premiums — Because you are paying your premiums in less time with a limited pay life policy, they will run higher than the premiums you would pay for a whole life policy over the course of your entire lifetime. These higher premiums could have a significant impact on your budget.
- Risk of Becoming a Modified Endowment Contract (MEC) — Limited pay life policies can run the risk of becoming a modified endowment contract or MEC because they involve overfunding life insurance, which involves the payment of extra money into a permanent life policy to boost their cash value. This overfunding can lead to adverse tax consequences if certain limits are exceeded as determined by the IRS.2 Be sure to discuss any potential tax implications with a financial representative as well as your tax professional.
- Opportunity Cost — Opportunity cost is the potential profit you might earn from investing your money elsewhere, rather than paying the higher premiums for a limited pay life policy. For example, depending on your life situation and overall financial goals, you may want to consider investing your money in stocks, bonds, or mutual funds as possible alternatives.
Should I Get a Limited Pay Life Insurance Policy?
Finding the right life insurance policy for you and your loved ones requires research, education, and due diligence. A limited pay life insurance policy may be especially appealing to those purchasing insurance later in life because they can get permanent coverage until they die, take advantage of the policy’s cash value while they are living, and finish making premium payments before entering retirement.
For example, a 50-year-old could purchase a 7 pay premium insurance policy and finish making their premium payments by age 57, years ahead of their potential retirement in their 60s. At age 50, someone is more likely to be an empty-nester and in the high earning years of their career, which may give them more financial ability (and freedom) to make the higher premium payments that accompany a limited pay life insurance policy. A 35-year-old parent with three young children with more financial obligations and budget constraints might find a different kind of policy — like term life insurance — a more affordable option than a limited pay whole life policy.
Is a Limited Pay Life Policy Right for Me?
Navigating your way through the different types of life insurance can feel a bit overwhelming, even when you’ve researched and educated yourself about your options. Determining whether a limited pay life policy is right for you depends on a variety of factors, including your age, financial objectives and budget. Now may be a good time to consult with an insurance professional.
A financial representative can meet with you to discuss your short- and long-term financial goals and provide you with some initial life insurance quotes. Having the support and guidance of an experienced insurance professional can help increase your peace of mind and help you find the right life insurance policy at a price you can afford — at this particular stage of your life — to meet your specific needs.
- Centers for Disease Control and Prevention’s National Center for Health Statistics (NCHS): “Provisional Life Expectancies for 2021.” https://www.cdc.gov/nchs/pressroom/nchs_press_releases/2022/20220831.htm.
- Administrative, Procedural, and Miscellaneous. https://www.irs.gov/pub/irs-drop/rp-01-42.pdf