Limited-pay whole life: 10-pay, 20-pay and paid-up at 65

Limited-pay whole life is whole life insurance that you pay off over a set number of years, such as 10 or 20, or until a set age such as 65, after which the policy is paid up and stays in force for life with no more premiums. Because the same lifetime cost is squeezed into fewer payments, each payment is much higher than on ordinary whole life, and cash value builds faster. It suits people who want lifetime coverage that is paid for before retirement and who can afford the larger premiums now.

How the pay periods work

On ordinary whole life you pay until you die, or until the policy's maturity age. On a limited-pay policy the contract specifies when premium-paying ends. Common versions:

The death benefit and cash value guarantees continue after premiums stop. The policy becomes a paid-up policy, which means no further premium is due. Insurers offer different menus, and not every age and pay period is available. Very short pay periods, such as 7-pay, run into a tax limit described below.

Why the premium is higher

You are funding the same lifetime benefit with fewer payments. A 20-pay policy needs a higher annual premium than a policy paid to death, and a 10-pay needs more than a 20-pay. In return, the policy accumulates reserves faster, so cash value is higher in the early and middle years than on ordinary whole life of the same death benefit. In the cash value comparison you see in an illustration, the shorter the pay period, the higher the early cash value and the lower the death benefit you can afford per premium dollar.

Insurers sometimes advertise lower total cost over a lifetime for limited pay, because you stop paying sooner. That requires keeping the policy for life. If you surrender early, the higher premiums may not pay off.

A hypothetical comparison

The numbers are invented to show structure, not prices.

Say a 35-year-old wants $200,000 of whole life.

Whether total premiums are actually lower depends on how long you live, since the ordinary policy keeps charging. Use the guaranteed columns of illustrations from the same insurer to compare.

Who limited-pay tends to suit

• People who want to be done with premiums before retirement. A paid-up policy has no payment in a period when income may fall.
• High earners with a lifelong need such as estate liquidity (see estate liquidity: paying taxes and debts without a fire sale) who can afford the premium.
• Parents or grandparents buying for a child, where the premiums are gifts and the policy becomes paid up when the child is an adult. See whole life insurance for children: pros and cons.
• Business owners funding buy-sell or key-person coverage who prefer a fixed number of payments.

Who it tends to fit poorly

• Families whose goal is the largest possible death benefit for the budget. The higher premium cuts the coverage you can afford.
• Anyone who might not be able to keep paying for 10 or 20 years. A missed payment early on leads to lapse or reduced paid-up coverage, and a surrender early on usually returns less than you paid.
• Buyers who have not asked whether the same money would work harder elsewhere. See is whole life insurance worth it? and buy term and invest the difference: does it hold up.

The tax limit on short pay periods

Federal tax law treats a policy that is funded too fast as a modified endowment contract (MEC). The seven-pay test compares the premiums you pay in the first seven years with a cap. A 10-pay policy is usually designed to fit below that cap, but a 7-pay or a single premium policy would exceed it. If a policy is a MEC, loans and withdrawals are taxed gain first and may carry a 10 percent additional tax before age 59 and a half. Policies that pay up quickly are where this matters most. See modified endowment contracts and the 7-pay test and section 7702.

Insurers also have maximums for the issue age of limited-pay policies, and some older applicants cannot get a short pay period.

Related designs

• Single premium whole life is the extreme case, one payment, and nearly always a MEC. See single-premium life insurance.
• Paid-up additions can let a policy become self-sustaining earlier by using dividends to pay premiums, an alternative to a formal limited-pay contract. See paid-up additions riders explained and life insurance dividend options: cash, paid-up additions and more. A "vanishing premium" projection is only a projection; it depends on non-guaranteed dividends.
• Modified whole life lowers early premiums instead. See modified and graded-premium whole life.

Questions to ask before choosing a pay period

1. What is the guaranteed premium, and does it ever change?
2. What are the guaranteed cash values by year, and how do they differ from the ordinary pay-for-life version?
3. If I stop after year 5, what do I get under the nonforfeiture options? See nonforfeiture options: reduced paid-up and extended term.
4. Is the policy a MEC, and what happens if I increase coverage?
5. Does the illustration assume dividends help pay premiums?

Key takeaways

• Limited-pay whole life ends premium payments after a set number of years or at a set age, and the coverage continues for life.
• The premiums are higher than ordinary whole life and the cash value grows faster in the early years.
• Very short pay periods can make the policy a MEC, with less favorable tax treatment for loans and withdrawals.
• It fits buyers with a lifelong need and a stable income; it fits poorly when the priority is the largest death benefit per dollar.
• Compare guaranteed values, not projections, when you choose between pay periods.