A vanishing premium policy is a type of permanent life insurance policy wherein a consumer can opt to utilize the dividends accruing from such a policy to pay its premium. After a given period of time, the cash value of the policy increases to a level where the sum of the dividends earned by the policyholder becomes equal to the total premium payment. When this happens, the premium is said to have disappeared or vanished, as the policyholder isn’t required to pay premiums out of her pocket anymore.
A vanishing premium policy is a type of permanent life insurance policy wherein a consumer can opt to utilize the dividends accruing from such a policy to pay its premium.
The policy is considered to be well suited to consumers who are worried about longer-term fluctuations in their income.
While the cash value of the dividend accumulates during the life of a vanishing premium policy, the insurer provides consumers with a tax-deferred benefit.
Features of Vanishing Premium Policies
The cash value of a vanishing premium policy generally increases over time. However, such an increase may occur in two ways. In some cases, the policy comes with high annual premiums in the policy’s initial years, during which only modest benefits are offered by the policy. Subsequently, as the benefits provided by the policy increase over time, the premium offered may decrease in tandem. This is the more common structure of vanishing premium policies.
In other cases, the policy comes with a fairly steady premium, along with a set amount of benefits offered to the holder. However, this only happens until the vanishing point of the policy is reached. The dividend payments that are used to cover premium payments in later years are pegged to the prevailing market interest rates. Thus, vanishing premium policies become more beneficial during periods of high interest rates.
When is a Vanishing Premium Policy Suitable?
A vanishing premium policy is considered to be well suited to consumers who are worried about long-term fluctuations in their income. Such people are typically those who are self-employed, would-be entrepreneurs, or individuals wishing to retire early.
Vanishing premium policies are also considered beneficial for consumers who are planning to utilize their policy benefits as supplemental income after their retirement. The policies are also used by some holders to facilitate estate planning.
In addition, policyholders receive tax benefits. While the cash value of the dividend accumulates during the life of the policy, consumers enjoy a tax-deferred benefit from the insurer.
Disadvantages of Vanishing Premium Policies
Consumers must be careful when signing up for a vanishing benefit policy. This is because relying completely on the policy’s maximum benefit feature comes with some risk. The amount of dividends earned can fall below the minimum amount required to meet the premiums, as market interest rates cannot be accurately predicted.
The amount credited to the cash value decreases when interest rates turn out to be lower than the expectation outlined in the insurance contract. In such cases, a policyholder would need to make premium payments for a longer period than they originally anticipated.
During high interest rate periods, the expectation is that the interest rates can only decline going forward. This means that it is not recommended for one to purchase a vanishing premium policy when interest rates reach historic highs.
Also, there also exists a high probability of misinformation and fraud by policy salesmen. In many cases, such as that of Canadian insurer Crown Life Insurance, employees of the insurer misled customers by understating the number of years for which the premium would need to be paid before it became “vanishing.”
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful: