Some clients may hesitate to invest in life insurance because of the large upfront costs and the long-term nature of most policies. That’s where advanced planning strategies like single premium immediate annuity (SPIA)-funded life insurance come into play. This strategy is designed for clients who want to ensure their life insurance policy is fully funded without worrying about ongoing premium payments. 

By leveraging a lump-sum investment, SPIA-funded life insurance allows clients to finance their life insurance premiums in a way that minimizes out-of-pocket costs after the initial payment. The client can deposit the lump sum directly into the life insurance policy. However, there are cases where funding the policy on a level and ongoing basis could help its performance while avoiding potential adverse tax situations like creating a modified endowment contract (MEC). 

What is a SPIA?

A SPIA is a financial product in which a client pays a lump sum upfront in exchange for guaranteed income payments that begin immediately. In the context of life insurance, the income from the SPIA is used to fund the policy’s premiums. For clients who prefer a hands-off approach, the SPIA removes the need to fund ongoing premium payments.

In addition to providing guaranteed income, SPIAs offer flexibility in payout structures. Clients can choose different payout schedules, whether monthly, quarterly, or annually, allowing them to align the income stream with their lifestyle and needs. Furthermore, SPIAs can be structured with certain guarantees, such as ensuring a minimum payout period or a return of premium if the annuitant passes away early, offering additional peace of mind to clients. 

Further, if the client ever has a financial emergency, a portion (or all) of the SPIA income can be redirected to where it is needed most. Simultaneously, the life insurance policy can be modified if necessary, such as reducing the face amount to prevent a premature lapse, given the decrease in premium funding.

How SPIA-funded life insurance works

Here’s a step-by-step look at how SPIA-funded life insurance works:

1. Initial lump sum: The client provides a significant lump sum, which could come from personal savings or a 1035 exchange—a tax-free transfer of life insurance or annuity assets. A 1035 exchange can be particularly valuable for individuals who have held underperforming life insurance policies and are looking for a more efficient way to use those funds.
2. Purchase of a SPIA: This lump sum is used to purchase a SPIA, which will pay out a guaranteed, steady income stream over time.
3. Funding the policy: The net income from the SPIA (after taxes) is directed toward the life insurance policy premiums, covering them without additional out-of-pocket payments. This guarantees the policy is funded consistently, avoiding the risk of missed payments or lapses.
4. Potential tax efficiency: Rather than pay a potentially significant tax all upfront (depending on the asset being used), a SPIA spreads out any income tax obligation as each payment is generated, meaning clients won’t need to worry about unexpected tax bills later.

The benefits of SPIA-funded life insurance

SPIA-funded life insurance is ideal for clients with a lump sum available and who want to secure life insurance coverage without worrying about how they will pay for premiums. Here are some of the key benefits

• Predictability and stability: Since the SPIA provides guaranteed income, clients know exactly what will be paid and when. This reliability can be especially important for retired clients or those managing multiple financial obligations.
• Tax efficiency: As mentioned earlier, taxes are generally accounted for within the SPIA payments, reducing administrative hassles for the client. SPIA-funded life insurance offers unique tax benefits that can be a game-changer for clients looking to minimize their taxable income. With traditional annuities or investment accounts, clients often face substantial tax bills from income or capital gains. SPIAs, on the other hand, allow clients to net out taxes from each payout, spreading the tax burden over the years and offering a smoother income stream that doesn’t drastically elevate their tax bracket.
• Estate planning flexibility: SPIA-funded life insurance helps clients preserve liquidity for heirs. Many high-net-worth individuals worry about estate taxes reducing the wealth passed on to their loved ones. By funding life insurance with a SPIA, they ensure that their heirs receive a substantial death benefit while minimizing the taxable income generated by the SPIA.
• Product availability: Some insurance products do not accept lump-sum premiums or 1035 exchanges. Converting a lump sum to a SPIA could potentially open up other product options that may not have been available otherwise.

For example, let’s say a client has $500,000 from a 1035 exchange. They can use this lump sum to purchase a SPIA, which guarantees annual payments of $30,000 for the next 20 years. These payments are then used to fund a life insurance policy with a $2 million death benefit. The policy is fully funded without the client needing to make further out-of-pocket contributions after the initial investment.

This setup ensures the client’s life insurance coverage stays in place without the stress of ongoing premiums, all while minimizing the taxable income generated by the SPIA.

Who is SPIA-funded life insurance right for?

This strategy won’t be right for every client, but it can be an attractive option for those with a lump sum to invest and a desire for financial simplicity. Clients approaching retirement or with excess cash from a 1035 exchange are ideal candidates. It’s a way to guarantee their life insurance remains in force while minimizing their ongoing financial obligations.

SPIA-funded life insurance is also ideal for clients who want to consolidate their financial products. Instead of managing multiple accounts, products, and payment schedules, they can simplify their financial planning by using one SPIA to fund a key part of their estate plan—life insurance. 

How to discuss SPIA-funded life insurance with clients

Introducing SPIA-funded life insurance to clients requires thoughtful discussion. Advisors should start by addressing their clients' key concerns—whether it’s high upfront costs, the fear of missed premium payments, or the complexity of managing several financial products. A SPIA-funded strategy can be positioned as a solution to these pain points, offering simplicity, predictability, and tax advantages.

Additionally, discussing how this strategy fits into broader financial goals can make it more compelling. For instance, if a client’s goal is to ensure a tax-efficient legacy for their heirs, SPIA-funded life insurance offers an accessible path to achieving that goal without the stress of ongoing payments or complex management.

Key takeaways

A SPIA-funded life insurance strategy provides:

• Consistent premium payments while reducing the risk of policy lapse.
• Tax efficiency through netted-out SPIA payments.
• Predictable cash flow to maintain life insurance coverage.
• Flexibility for estate planning with minimal out-of-pocket costs after the initial investment.

Offering clients a simple, tax-efficient way to secure life insurance helps them achieve peace of mind and protection for their loved ones. Consider discussing SPIA-funded life insurance with clients looking to maximize their coverage with minimal effort.

Next steps

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