Endowment Life Insurance 101

Life Insurance that can Pay before you Die

Kirby Thomas
Online Life Insurance CompPRO+ in San Diego, CA

Insurance Life Insurance

Endowment Life Insurance 101
February 24, 2016

Endowment life insurance is similar to whole-life insurance in two ways: your policy premiums go toward both a benefit component and investment component, and a minimum payment to the beneficiary is guaranteed. The big difference is that the term for endowment policies is not tied to your expected lifespan and payout can occur during your lifetime.

Terms are set for a certain numbers of years, often in the range of ten to twenty. Should you die before the term ends, your beneficiary will receive the guaranteed benefit just as they would with any other life insurance policy. Should you live beyond the end of the term, you receive the total value, which may be greater than the guaranteed benefit depending on the type of policy and the return that was received on the investment portion.

The death benefit is tax-free to a beneficiary since premium payments are in after-tax dollars. Taxes will be due on any bonuses that are paid (value of the investment above the face value).

Endowment insurance is typically used to accumulate money toward a particular financial goal, such as a down payment on a retirement/second home or for funding a child’s college education, while adding a life-insurance component.

This type of insurance used to be a very popular method of saving for college, because it allows money to grow tax-deferred and does not count as assets that reduce eligibility for student aid. However, the more recent development of state 529 plans and ESA’s have replaced endowment insurance as a preferred program for college costs.

The greatest downside of endowment insurance is the higher premium you pay. Premiums are generally even higher than with a traditional whole life policy. The returns for the premiums paid are often poor, and in today’s market, there are generally better options.

Endowment insurance used to be considered more as a cash-value generator than a life insurance policy. Congress put a stop to that in the 1984 Tax Reform Act, which eliminated the tax benefits of a life insurance policy if the cash-value grew beyond a certain rate. In 1988, a middle ground threshold was established with Modified Endowment Contracts (MECs) that allow higher premiums and returns. These policies are still considered as life insurance products, but you will lose the tax-deferred status of the growth of the cash-value.

By definition, this gives standard endowment insurance relatively low rates of return, and takes away tax advantages if you have a higher-cash-value MEC policy. Since you choose how much you put in for premiums, you need to be aware of this aspect to keep tax-deferred status on your gains and avoid penalties. Paying too high of a premium in the first seven years will cross your policy over to MEC status, which cannot be rescinded with lesser payments in future years.

The legislation from the 1980’s put endowment insurance in sort of a no-man’s land. Typically, you can find life insurance products and specific savings and investment plans separately (such as relatively simple term life insurance combined with a 529 college savings plan) and come out ahead financially.

However, if you like the convenience of combining the life insurance and investment aspects into one policy, and are saving for a specific financial goal for you or a beneficiary during your expected lifetime, then endowment insurance may be right for you. Consult an insurance professional to make sure that you understand all of the tax ramifications and other issues, and to help you verify whether an MEC or standard endowment insurance is better for your needs.

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Photo ©iStockphoto.com/nyanza

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