Universal Life Insurance Premiums

Universal life insurance, whether it is guaranteed universal life insurance, indexed universal life insurance, or traditional universal life insurance, has a few different types of premiums. The purpose of these premiums is to set minimum and maximum amounts that you can put into a policy.

They maximum premiums are part of the guideline premium test, which is one of two tests that life insurance policies can use under federal tax law.

We’ll go over each one in this article:

  • Minimum premium
  • Guideline single premium
  • Guideline level premium
  • 7-pay premium

We will also include some numerical examples.

Minimum Premium

Many universal life policies have a no-lapse guarantee provision for a specified number of years. These provisions guarantee that a policy will not lapse if some minimum premium is paid. Often you will see these no-lapse guarantees last for 15 to 20 years.

After the guarantee period ends, if you have been paying the minimum premium, there is no guarantee that the policy will not lapse. Minimum premiums vary by company, underwriting class, age, etc.

Other than guaranteed universal life insurance, you should not be paying a minimal premium when you purchase universal life insurance. It would be much more cost effective to purchase term insurance.

Usually these premiums are on a cumulative basis, so if you had paid more than the minimum and then stopped making payments, the guarantee would last until the cumulative amount of the minimum payments reach what you have paid in.

Bottom line: in general, don’t purchase universal life insurance if you are looking for low cost, temporary coverage. That’s what term insurance is for, and it will do it much cheaper.

Guideline Single Premium

Unlike the minimum premium, all of the remaining premium types we’ll discuss are a product of the tax code.

In order to qualify as life insurance, you cannot pay more than the guideline single premium (GSP) into a policy (at least until the guideline level premium exceeds it on a cumulative basis, which we’ll talk about below).

This typically is a large amount, so most people wouldn’t be paying it anyway. Though, there are instances where policies are funded with a single premium.

If a policy did not qualify as life insurance, death benefits would be taxable, among other things that you want to avoid. I don’t even think companies would allow you to fund a life insurance policy in such a way that it would no longer be considered life insurance from a tax law perspective.

Note that just because you have not violated the guideline single premium stipulation, a policy could still be considered a modified endowment contract (MEC), which we will discuss below.

Guideline Level Premium

The guideline level premium (GLP) is used in conjunction with the guideline single premium. In order to qualify as life insurance, cumulative premiums paid must be less than the greater of the guideline single premium or the cumulative amount of the guideline level premiums.

Practically speaking, this means that at first the guideline single premium will be the premium limit to qualify as life insurance. Eventually though, the cumulative amount of the guideline premiums will exceed the guideline single premium.

But, you can pass the guideline single premium/guideline level test (i.e. qualify as life insurance), but still be considered a MEC.

It is also worth noting that in addition to premium limits, there are also “corridor factors” that must be adhered to in order to qualify as life insurance. These factors set a minimum death benefit for a given cash value and vary by age. As age increases, the death benefit is allowed to be closer to the cash value.

7-Pay Premium

While your policy may have passed the GSP/GLP and corridor factor test, it must also pass a 7-pay test in order not to be considered a MEC.

MECs are still life insurance, but policy loans and withdrawals are taxed on a gain-out-first (also known as last in first out, or LIFO) basis. And, there are penalties for withdrawals before age 59 and a half. Essentially MECs are taxed like annuities, except that there is still a tax-free death benefit.

The 7-pay premium works like the guideline level premium in that it is cumulative. In order not to be considered a MEC, during the first seven policy years, a policy’s cumulative premiums must not exceed the cumulative amount of the 7-pay premium. After 7 years it goes back strictly to the GSP/GLP and corridor factor test.

Either the GLP or GSP could be larger, it just depends on the circumstances.

What the 7-pay premium accomplishes is to limit the amount of premiums paid in the early years of the policy, which otherwise could be very high due to the GSP.

Finally, the GLP and 7-pay premium cumulative calculation is performed on an annual (policy year) basis. So, you could pay the entire annual amount in the first policy month and be just fine.

Why Are There All of These Rules?

These rules did not always exist in the tax code. Due to the favorable tax treatment of life insurance, it is tempting to put in as much premium as possible for a given death benefit, thereby paying for very little insurance and avoiding taxation.

So, Congress decided to limit how much premium could be paid in by specifying various rules and calculation methodologies. This ensure that there is a meaningful amount of life insurance and it is not purely a tax shelter.

Why You Should Pay Attention to These Amounts

If you are going to purchase a universal life insurance policy (or any permanent policy), you need to make sure it is funded the “right” way. In our opinion, that means funding at or near the levels that the tax code allows.

This does a few things. First, it minimizes the cost that you will pay for insurance and allows your cash value to grow as efficiently as possible. Second, it greatly reduces commissions for a given premium.

This is good for your cash value. Third, you won’t need to worry about having an underfunded policy that might lapse in the future.

If you want a big death benefit, term is most likely your best option. If you want a big permanent death benefit, it is going to be very expensive to fund it properly.

Examples

These examples will list some sample GSP, GLP, and 7-pay premiums and show the maximum amount that can be put into the policy (premiums are annual).

Policy 1:

  • GSP: $32,160.98
  • GLP: $2,550.61
  • 7-pay premium: $6,900.77

Policy 2:

  • GSP: $32,160.98
  • GLP: $7,350.35
  • 7-pay premium: $6,900.77

These are based on two slightly different policies, and you might notice that the only difference between them is the GLP.

As mentioned earlier, sometimes the GLP is larger than the 7-pay premium and sometimes it is not (you can see that in these two examples).

The tables below show all of this works out in practice. Here is what each column represents:

  • Column 1: this is the guideline single premium. It never changes.
  • Column 2: this is the cumulative amount of the guideline premiums. It goes up by the same amount each year.
  • Column 3: this is the greater of columns 1 and 2. The greater of these amounts is the maximum amount (on a cumulative basis) that can be paid into the policy and still qualify as life insurance (though it could still be a MEC).
  • Column 4: this is the cumulative 7-pay premium that’s used for determining the policy’s MEC status. It goes up by the same amount each year, and after year 7 it is no longer relevant.
  • Column 5: this is the smaller of columns 3 and 4. This represents the maximum amount that can be paid into the policy while still qualifying as life insurance and not becoming a MEC. Sometimes column 3 is the limiting factor and sometimes column 4 is.
  • Column 6: this is the maximum amount that can be put in each year (not cumulative). It is the difference in column 5 from year to year. In some cases, there will be many years that no premiums can be paid in. In other cases, after the initial 7-year period, there could be one or more years in which a higher than usual premium can be paid. The two scenarios are both represented in the tables.
  • The tables go out 15 years. Beyond that, nothing changes in column 6, as the GLP is the limiting factor.

Sample premiums for policy 1:

Year GSP GLP Max of GSP and GLP 7-Pay Min of 7-Pay and GSP/GLP Max Annual
1 $32,160.98 $2,550.61 $32,160.98 $6,900.77 $6,900.77 $6,900.77
2 $32,160.98 $5,101.22 $32,160.98 $13,801.54 $13,801.54 $6,900.77
3 $32,160.98 $7,651.83 $32,160.98 $20,702.31 $20,702.31 $6,900.77
4 $32,160.98 $10,202.44 $32,160.98 $27,603.08 $27,603.08 $6,900.77
5 $32,160.98 $12,753.05 $32,160.98 $34,503.85 $32,160.98 $4,557.90
6 $32,160.98 $15,306.66 $32,160.98 $41,404.62 $32,160.98 $0
7 $32,160.98 $17,854.27 $32,160.98 $48,305.39 $32,160.98 $0
8 $32,160.98 $20,404.88 $32,160.98 NA $32,160.98 $0
9 $32,160.98 $22,955.49 $32,160.98 NA $32,160.98 $0
10 $32,160.98 $25,506.10 $32,160.98 NA $32,160.98 $0
11 $32,160.98 $28,056.71 $32,160.98 NA $32,160.98 $0
12 $32,160.98 $30,607.32 $32,160.98 NA $32,160.98 $0
13 $32,160.98 $33,157.93 $33,157.93 NA $33,157.93 $996.95
14 $32,160.98 $35,708.54 $35,708.54 NA $35,708.54  $2,550.61
15 $32,160.98 $38,259.15 $38,259.15 NA $38,259.15 $2,550.61

Sample premiums for policy 2:

Year GSP GLP Max of GSP and GLP 7-Pay Min of 7-Pay and GSP/GLP Max Annual
1 $32,160.98 $7,350.35 $32,160.98 $6,900.77 $6,900.77 $6,900.77
2 $32,160.98 $14,700.70 $32,160.98 $13,801.54 $13,801.54 $6,900.77
3 $32,160.98 $22,051.05 $32,160.98 $20,702.31 $20,702.31 $6,900.77
4 $32,160.98 $29,401.40 $32,160.98 $27,603.08 $27,603.08 $6,900.77
5 $32,160.98 $36,751.75 $36,751.75 $34,503.85 $34,503.85 $6,900.77
6 $32,160.98 $44,102.10 $44,102.10 $41,404.62 $41,404.62 $6,900.77
7 $32,160.98 $51,452.45 $51,452.45 $48,305.39 $48,305.39 $6,900.77
8 $32,160.98 $58,802.80 $58,802.80 NA $58,802.80 $10,497.41
9 $32,160.98 $66,153.15 $66,153.15 NA $66,153.15 $7,350.35
10 $32,160.98 $73,503.50 $73,503.50 NA $73,503.50 $7,350.35
11 $32,160.98 $80,853.85 $80,853.85 NA $80,853.85 $7,350.35
12 $32,160.98 $88,204.20 $88,204.20 NA $88,204.20 $7,350.35
13 $32,160.98 $95,554.55 $95,554.55 NA $95,554.55 $7,350.35
14 $32,160.98 $102,904.90 $102,904.90 NA $102,904.90 $7,350.35
15 $32,160.98 $110,255.25 $110,255.25 NA $110,255.25 $7,350.35

Conclusion

The guideline single premium, guideline level premium, and 7-pay premium are all used in conjunction to determine a policy’s status as life insurance and a modified endowment contract.

You will never have to worry about how these premiums are calculated. The insurance company does this automatically and they will be listed on your contract.

If you have a universal life policy, it will also tell you if the amount you have been paying in is close to these limits. In our opinion, if you are going to buy universal life insurance, you should do so with the intention of paying premiums that are close to or equal to these limits.

It can also tell you if your agent did a “good” job. A common thing that we come across is underfunded universal life insurance policies.

If you intend to pay a low premium and just want death benefit protection, stick to term insurance.

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