A limited pay whole life policy is a permanent insurance policy guaranteed to be fully paid-up at a certain date, or when you reach a certain age, with no more premiums due. In most cases, whole life policies pay a tax-free death benefit to beneficiaries when the insured dies. There is no set term—whole life policies build cash value over time, and this cash value exists to support the death benefit when the policy owner no longer pays premiums.
Permanent vs. Term Life Insurance
Permanent insurance, which includes whole life insurance, is designed to pay out a death benefit no matter when the insured dies. Term life insurance only pays a death claim if the insured dies during the time the policy is in force. Because death is a sure thing, and people rarely die while a term policy is in force, premiums are much higher for a whole life policy than for a term policy. However, receipt of the death benefit is guaranteed, provided premiums are paid, while term policies typically become too expensive to maintain or run out altogether.
Structure of Whole Life Policies
Whole life policies feature a guaranteed level death benefit for life, and a guaranteed level premium for life. While term policies feature lower premiums eventually, term premiums go up as the insured gets older, while whole life premiums are guaranteed never to increase. Since you pay more in premiums in the early years of the policy than you would in a term policy, the excess premium goes into the cash value of the policy, which represents the reserves the insurance company sets aside to cover the eventual death benefit. The cash value grows at a guaranteed rate until age 121, when the cash value is designed to equal the death benefit. At that time, the policy "endows," and the insurance company pays out the death benefit.
Limited Pay Policies
By committing to higher premium payments, the policy owner can sometimes get a guaranteed paid-up date. The policy owner pays extra premium to bring the policy cash value to the point where the interest from the cash value itself will be sufficient, in the estimation of the insurance company, to pay the death benefit. Not every company offers this option, and some only offer limited-pay policies up to a certain age, such as 65. Some companies allow the customer to select the age at which the policy becomes paid up, or the term of payment.
Tax Treatment of Life Insurance
Congress provides life insurance policies with a number of tax advantages—chiefly the tax-free build up of life insurance cash value. Policyholders may tap the cumulated cash value to supplement retirement income or for any other reason, tax-free, provided the policy was properly structured when it was sold. Life insurance cash value may also be converted into an annuity without generating a taxable event. However, if the policy lapses, the IRS will deem any outstanding loan balance in excess of the premiums you have paid in to be a capital gain.