What Is Limited Pay Life Insurance?

Lynda Taylor is an assistant director of Risk Product Development at Northwestern Mutual.

There are many different types of life insurance to help people who may have different needs and goals. One option you might see is limited pay life insurance. Here’s how it works.

How does a limited pay life insurance policy work? 

A limited pay life insurance policy is a type of whole life insurance. This type of insurance is designed to be permanent—unlike term life insurance, which is designed to be temporary.

If you choose limited pay, you’ll select the number of years to pay. Once the policy starts, you’ll owe premiums for that time frame.

Limited pay life policy example

Let’s say you just turned 45 years old, and you start a 15-year limited pay policy. You’ll owe premiums until you turn 60. But the great thing is that once you finish paying, the insurance remains active until you pass away. (You could also surrender the policy and take its cash value—but doing this would likely result in you owing tax on policy gains). Assuming you leave the policy in place, your beneficiary will eventually get the death benefit payout.

If you have a mortgage for a house or condo, you probably made a similar decision before you signed on the bottom line. Your lender might have offered you a 30-year mortgage or a 15-year mortgage, the length of time and size of the monthly payments being the main difference between the two. Your payments would be higher with the 15-year time frame, but you finish paying much sooner, and your total outlay is less. Whether you choose 30 or 15 years, you’ll eventually own the house. You could think of limited pay like choosing a mortgage with a shorter duration. You pay more for a shorter time and end up spending less overall.

Now that you understand how a limited pay policy works, let’s look at some of the pros and cons.

Benefits of a limited pay life policy 

Since it’s whole life insurance, limited pay shares most of the benefits of whole life insurance.

The main difference between limited pay and other types of whole life insurance is that you pay the premiums for a certain number of years. Typically, it’s a much smaller payment time frame than that for a traditional policy, which requires premiums to an age like 100. Because limited pay condenses the premiums into fewer years, monthly premiums are higher than for similar policies.

Your financial advisor can get to know you and your financial goals. Then they can help explain what might work best for your situation. You might choose limited pay because:

It fits your life.

For example, you might plan to retire or switch jobs in 15 years, so you want to be done paying premiums by then. Or you might want to finish paying premiums on a policy insuring a child before they turn 18. In other words, the timeframe might match how you see your life going.

The cash value could increase faster.

Whole life policies accumulate cash value.  If you paid premiums over a shorter time frame, the cash value would increase faster compared to a similar policy with a longer time frame.

Because a limited pay policy is a type of whole life policy, you’ll also get all the benefits that come with whole life insurance, like:

The policy doesn’t expire.

As long as you’ve paid your premiums, your death benefit will never expire. Your beneficiary is guaranteed to get the payout when you die.

Premiums stay the same.

The monthly payments for your policy will remain fixed and consistent until you finish paying.

Dividends are possible.

Many life insurance companies pay dividends.¹ You can take dividends as cash or use them to help pay your premium, but many people reinvest them in their policies. That can allow the death benefit and cash value to accumulate even more quickly.

Cash value builds.

A portion of every premium payment is added to your policy’s cash value. As described above, it will increase more quickly than a comparable policy that isn’t limited pay. Having cash value provides significant financial flexibility during your life—especially in retirement. And cash value is guaranteed to grow tax-deferred and isn’t affected by market volatility.

You and your family get tax advantages.

Your beneficiary usually gets the death benefit tax-free. And you can borrow against your cash value without paying taxes²  as long as the loans are repaid properly.

For all these reasons, a limited pay life insurance policy can be a great part of your overall plan for financial security and growth. But there are some drawbacks to think about before you decide.

Drawbacks of a limited pay life policy

Cost

The relatively high premium is the primary barrier that steers some people to other types of life insurance. Since you aren’t paying into the policy to an advanced age like 100, it makes sense that the monthly payments are higher than a comparable policy. The shorter the paying time frame, the higher the payment, so a 10-year policy has higher payments than a 25-year policy. Some companies allow you to decide how often you pay—monthly, quarterly or yearly.

It’s important to talk with a financial advisor and be confident that you’ll be able to afford the policy for the years to come. If you’re unsure if the premium will work within your budget, a different type of whole life insurance—or even term life insurance—might make more sense.

Tax considerations

On the flip side, you have to be careful about putting too much money into the policy. Sometimes people do this when they receive an inheritance, get a larger-than-expected bonus or simply have cash available. Heavily “overfunding” or paying significantly more than the amount due on your policy could cause its classification as a modified endowment contract, resulting in lost tax benefits and other impacts. The company will notify you when you attempt the extra payment.

Work with a financial advisor to find the right policy for you

You have a lot of options with life insurance. Your time frame, financial situation and legacy goals are all important things to consider. Your Northwestern Mutual financial advisor can help you determine what type of insurance makes sense for you—based on your financial goals and values. They can also show you how life insurance can work alongside your investments as part of a holistic financial plan to help you feel more confident about reaching your financial goals.