Buying Insurance: Pros & Cons Of Limited Premium Payment Term
An article by SingSaver
Paying for long-term insurance coverage within the best years of your working life has its perks. Here’s your guide to limited premium payment terms and how it might provide you with peace of mind.
When it comes to insurance plans, there is no one-size-fits-all. Similarly, when it comes to making payment for our insurance plans, be it in the hundreds or thousands, there are bound to be different preferences for payment terms. Some might prefer to pay monthly, viewing the premiums as a recurring monthly expense.Others might prefer to pay one-off bills every year.
Limited premium payment terms (sometimes known simply as limited pay) is a payment option for certain types of insurance plans. These plans include life insurance (both term life and whole life) and endowment plans.
Types of premiums available
Premiums are what you pay for the insurance plan, in order to enjoy the corresponding coverage. Before we go into limited premium payment terms, here are a few different types of premium payment types offered for insurance plans:
- Single premium: These are premiums that you pay once as a lump sum upfront to enjoy the coverage until maturity. Insurance plans that commonly feature single premiums include endowment and retirement plans.
- Regular premium payments: These premiums have to be paid on a regular basis, such as annually, bi-annually, quarterly or monthly. This often applies to endowment, health, life and critical illness plans
- Renewable premiums: These are premiums that you can renew and pay to enjoy additional years of coverage. Examples of such insurance plans that are renewable include general insurance such as home, maid, car and some health and term life insurance. You can renew your policy in order to continue enjoying the coverage, or simply buy a new plan. However, the premium may be revised according to your age and other factors upon renewal.
- Level term premiums: Your premiums tend to increase with age. But for level term premiums, the premium amount stays at the same level. They can be offered for life insurance plans and are determined by factors such as your age and health. However, they are not guaranteed.
Some policies also have a guaranteed renewable feature that allows you to remain covered regardless of your health condition as long as the premiums are paid on time. However, these premiums can still increase based on various contributing factors.
What about limited premium payment terms?
Limited premium payment term is rather self-explanatory: you pay your premiums only for a limited number of years within the policy term. This limited period is a tenure that is shorter than your coverage period. These premiums are adjusted to the predetermined timeframe and are to be paid within the selected term. After paying the premiums for that period of time, you continue to enjoy the coverage for the full policy period.
Limited premium payment can feature in life insurance policies and endowment plans.
For example, the Manulife LifeReady Plus II is a limited payment whole life plan that allows you to choose from 5 different premium payment options, offering payments over 10, 15, 20 and 25 years, or till age 99. Should you choose the 10-year option, you pay the premiums for this whole life plan for the first 10 years of the plan. Upon payment of the premiums for all 10 years, you will enjoy the whole life coverage for life!
An example of a limited pay endowment plan is the Aviva MyWealthPlan, which offers a 5 and 10 year premium payment term option. Interestingly, this plan guarantees your capital upon maturity only for limited-pay plans.
You can read more about the best endowment plans in Singapore here.
TL;DR: The good and bad of limited payment term
|Pay more during your higher income-earning years||Less affordable in pure dollar terms|
|Premiums will not increase with age||Decide on your payment term at the start|
|Flexibility of choosing a premium payment option that suits your circumstances||Opportunity cost of the premiums spent in the earlier years|
|Finish paying premiums earlier|
|Tap on the power of compounding to grow cash on cash|
Pros of limited premium payment term
#1 Pay more during your higher income-earning years
On paper, it looks counter-intuitive that paying more is a pro. But this is beneficial for you in this case because you pay for the premiums (albeit higher) during your younger years – over a shorter period – which is likely a time when you are actively working and earning a stable income. You might also have fewer financial commitments on your plate, such as servicing mortgage payments or looking after young children and elderly parents.
In essence, your younger self is paying for your older self to enjoy the coverage.
#2 Premiums will not increase with age
With a limited premium payment term, your premiums are fixed, having been calculated based on the term you selected when enrolling for the insurance plan. They will not change with time as you age. This allows you to better plan and allocate your finances when you know where some fixed expenses will be going every year. If you can afford the insurance plan in Year 1, barring unforeseen circumstances, it is likely to be a premium amount that you can afford to pay for the rest of the term.
#3 Flexibility of premium payment periods
Limited premium payment terms can be offered across a range of term periods. For example, there are payment terms of 5, 10, 15, 20 and 25 years. This allows you to choose a payment period that best suits your spending habits, budget, personal preferences, financial situation and goals in life.
A shorter premium period can make financial sense if you are earning reasonably more than you spend, have substantial savings or have few financial commitments in the near future.
#4 You finish paying premiums earlier
An underlying reason to choose a limited premium payment term is that you finish paying the premiums earlier. Your payments end within a stipulated time frame and you enjoy coverage beyond the premium payment years.
For example, paying 12 years for a whole life plan starting from the age of 25 can see you finishing paying all premiums by age 37 and enjoying coverage for the rest of your life. This gives you the peace of mind knowing that your insurance coverage has already been paid for and you can dedicate your focus to other goals such as early retirement. You also have the freedom to channel what you’ve been spending each year on the premiums to other purchases.
#5 Front load to tap on the power of compounding
To make the most of your money, you can grow cash on cash by front loading your endowment plan — much like how starting from young is encouraged when it comes to investing. The faster you make your premium payments, the more cash goes into the plan and the longer the time period your cash has to grow and earn the non-guaranteed interest.
Cons of limited premium payment term
#1 Less affordable in pure dollar terms
In absolute dollar terms, you pay more each month when you select a shorter payment tenure, compared to spreading the payment across the entire course of the policy term. This higher premium amount per month could be financially taxing, particularly if it takes up a large portion of your take home salary.
It could also have repercussions such as delaying the build-up of your emergency fund, or not having spare cash to invest.
This is similar to other financial decisions you have to make, which require a selected payment period. For example, a home loan of 10 years will require a higher monthly mortgage payment compared to a home loan that is paid off over 30 years.
#2 Decide on your payment term at the start
You will have to decide on the premium payment term at the very start, during the application. This means that your decision has to be made today, without knowing what the future might bring.
There could be unforeseen circumstances such as a retrenchment, health issues, or a baby on the way that may send monthly expenditures spiralling out of control. Being committed to the premium payment leaves you little wiggle room to spend your money as you wish. It could even render you unable to pay the premiums in these years.
However, there are benefits within some insurance plans that act as a fail-safe for such a scenario, such as partial withdrawals, policy loans and premium holidays.
#3 Opportunity cost of the premiums spent in the earlier years
On the flipside, there is an opportunity cost when opting for limited premium payment terms. Forking out more during each insurance payment may allow you to finish paying earlier; however, if your premiums were spread out over a longer timeframe with lower premiums for each payment, you could have more cash on hand to grow your money.
The extra dollars you spent to pay for your premiums could have gone into an investment portfolio during your early years, compounded over the long run, and reaped higher returns.
This opportunity cost is a key reason behind choosing to buy term and invest the rest.
Should you choose a limited premium payment term?
The decision to choose a limited premium payment term depends on many different factors. Then, there are also considerations that are difficult to put a number to, such as peace of mind.
Here are the factors and the questions to ask yourself to help you come to a decision:
- Can you afford to pay the premiums over fewer years? Do you earn enough to comfortably be paying this premium for the coming years?
- What does your financial situation look like? Have you built your emergency fund? Do you have cash on hand such that you can well afford these payments, particularly in the coming years?
- What are your career plans? Do you plan to be working for the most part of your life, or do you plan to have a shorter career and retire early? You could consider paying for some of these plans when you have a stable income or when you are earning more.
- What is your personal preference? Is it peace of mind knowing that you have paid for your coverage in your later years, or is it to utilise these additional dollars today for your investments?
This ultimately boils down to your financial goals. Unlike a limited pay insurance plan, paying premiums for the entire duration of a plan could see you continuing to pay even into your retirement years. If your idea of retirement is to sit back comfortably and enjoy the fruits of your labour, a limited premium payment term could be the preferred option.
This article was first published on SingSaver and republished on InsuranceFirst. The opinions are of the original publisher and do not wholly reflect InsuranceFirst.