Paid-Up Additional Insurance: Boost Your Policy's Cash Value
Do you want to maximize the benefits you can receive from your whole life insurance policy? Purchasing paid-up additional insurance allows you to increase your life insurance's cash value, which provides your beneficiaries with more money upon your death.
In this comprehensive overview, we'll talk about how paid-up additional insurance works and the benefits it offers. We'll also answer the most frequently asked questions on the topic.
Defining Paid-Up Additional Insurance
When you purchase a whole life insurance policy, a large part of the premiums you pay goes to the cost of insurance. A smaller part goes to a high-interest cash value account.
Over time, the cash value grows, and the insurance company invests the money to produce dividends. If you choose to keep those dividends within the policy instead of withdrawing them, their value will continue to grow.
A whole life insurance policy is considered "paid-up" when it gets money from the cash value to pay any remaining premiums, so you no longer have to pay anything out-of-pocket. This is an option strictly for dividend-paying whole life insurance. It does not apply to term life insurance policies because they don't accumulate cash value.
A life insurance policy is also considered "paid-up" when you've contributed enough of your premiums to equal the death benefit. When this happens, the part of the premiums that go to your cash value increases.
Types Of Paid-Up Life Insurance
There are two types of paid-up life insurance. In this section, we'll talk about the different qualities of each and how they work.
Before we explain paid-up additions (PUA), it's crucial to first explain the concept of policy riders. Insurance policy riders refer to add-on benefits that provide more coverage and protection, typically for an additional fee. Some examples of common examples of these are accidental death or disability riders.
A paid-up additional rider (also known as an enricher rider) allows you to purchase paid-up additions, which are "mini-policies" within a main whole life policy. Most of the time, people buy a paid-up additions rider at the same time they buy their main whole life policy.
Keep in mind, though, that eligibility will depend on the insurance company, your age, and your health. You can also add a paid-up insurance rider to an existing policy, although this comes with additional requirements.
So, what's the point of buying paid-up additions? Each of these "mini policies" has its own cash value and its own death benefit. As they stack up, the value of your life insurance policy grows. You can have as many paid-up additions as you want within your main life insurance policy.
Another thing that makes paid-up additional insurance riders attractive is that they also earn their own dividends. This way, your policy's cash value can grow even more because of compounded interest. Plus, there’s a tax advantage that comes with purchasing additional life insurance.
Financing Insurance Additions
Paid-up insurance additions can be bought in two ways: by paying additional premiums or by using the dividend you earn from your original policy.
In the first method, you'll have to pay more money upfront. It may seem disadvantageous in the beginning, but by doing this, your policy's cash value will grow faster and generate better returns.
The value of the paid-up additions will be equal to the money you used to purchase it. For example, if you bought paid-up additions for $5,000, its value will be $5,000 as well.
The second way to purchase paid-up additions is by using dividends. Dividends are annual payments from member-owned mutual insurance companies. These payments depend on the company's financial performance, so they're not guaranteed, but some companies have a strong track record of paying dividends year after year.
Some whole life insurance policies can be converted to a paid-up policy. Once you do this, you can keep the whole life insurance without having to pay additional premiums.
This is especially useful if you're having trouble paying the monthly dues to keep your whole life insurance policy active. Instead of allowing the policy to lapse, you can keep it in force by using your dividends and money from the account to pay the premiums.
Note that this is only an option for those whose whole life insurance policies have built up a significant cash value. If your cash value dries out, you may need to pay premiums again.
Another thing to keep in mind is that not all whole life insurance policies allow you to convert them into paid-up status. Contact your insurance company to learn if this is an option for you.
Paid-Up Additions Example
Let's say you buy a life insurance policy with a $300,000 death benefit for a premium payment of $5,000 annually. You've also agreed to pay $5,000 extra as payment for the paid-up additions rider. This immediately pumps up the cash value by $5,000 and increases the death benefit by $25,000.
You paid only $10,000 in the first year, but now you get coverage of $300,000 (from the original policy) plus $25,000 (from the paid-up additions rider). As you purchase more paid-up additions, the value and the death benefit will continue to increase.
Level vs Flexible Paid-Up Additions Rider
In the previous sections, we talked about how a paid-up additions rider enables you to purchase mini-policies within your main life insurance policy. Here, we'll discuss the two types of paid-up life insurance riders available.
The type of rider you have will determine the number of mini-policies you can buy each year. You may also be required to purchase a certain number of additions annually, depending on the insurer you choose.
Level Paid-Up Additions Rider
For this rider, you'll be restricted to a certain amount of paid-up additions you can buy annually. You won't be able to increase the amount of paid-up additions you purchase every year, but you may be able to lower it.
Flexible Paid-Up Additions Rider
If you get this rider, you'll be able to purchase any number of paid-up additions annually, provided it falls within a range specified by your insurer. Since it doesn’t specify exactly how much you should purchase, you can increase or decrease how much money you spend on additions. If you have less cash to spare, for example, you can purchase fewer additions.
There are a few things you have to keep in mind before you buy insurance additions to build up your policy's cash value.
First, the Internal Revenue Service (IRS) monitors insurance policies with a cash value that’s very large compared to the death benefit, putting a tax on those that exceed their set federal limits. An overfunded policy is called a modified endowment contract (MEC). Insurance companies should advise you about the cash value limitations, so you don't end up falling into this tax trap.
Second, some insurance companies require you to buy paid-up additions annually. If you don't comply, you forfeit the right to purchase additions ever again.
Third, most life insurance companies charge a one-time load fee each time you buy paid-up insurance additions. This can cost anywhere from 5-10% of each PUA. For example, you can purchase a PUA for $1,000 and pay 10% (or $100) to the insurance company. The remaining $900 will go toward the cash value of the PUA.
Benefits Of Paid-Up Additional Insurance
Buying paid-up additional insurance on top of your main life insurance policy comes with several benefits. Here's a quick summary of each.
Builds Cash Value Quicker
Paid-up additional insurance works like a "miniature insurance policy" inside a whole life policy. Your PUA rider carries its own death benefit and also has its own value. It earns its own dividends, making it a good option for those who are looking to grow their wealth through compounded interest.
Earns Tax-Deferred Growth
If you leave your dividends within your original whole life policy, it will be considered taxable income. Alternatively, you can use your dividends to purchase paid-up additions and gain a tax incentive under IRC 7702.
Does Not Require Medical Underwriting
In most cases, buying paid-up additions won't require you to undergo a medical exam. Paid-up additions enable you to increase your insurance coverage even if you've developed a medical condition that normally would disqualify you from obtaining insurance coverage through other means.
Requires No Additional Payments
When you purchase paid-up insurance (either through dividends or out-of-pocket), they're considered "paid in full." So, you don't have to make additional premium payments to retain your coverage when you stop working.
Creates An Increasing Death Benefit
One advantage of getting a whole life insurance policy with a paid-up additions rider is that you can start with a smaller death benefit, which translates to lower premiums. You can purchase additions year after year to increase the death benefit and gain better coverage.
Includes An Instant Death Benefit
Depending on the type of whole life insurance policy that you have, you may not be covered from day one. That's because some of them require a waiting period before the death benefit becomes available.
However, if you buy paid-up additions, your dependents are eligible to claim the benefit from the "mini policy" as soon as you purchase it. That way, you and your family can benefit from immediate financial protection.
One of the reasons it's good to have a whole life insurance policy with a large cash value is that it provides liquidity. This means that you can take a loan from your whole life policy to fund investments, pay off debts, cover daily expenses, etc.
Compared to taking out a loan from a bank or another credit institution, you don't need any credit approval to take a loan against a whole life insurance policy's cash value. If you fail to pay back the money, it will be deducted against the death benefit.
Note that your mutual insurance company will charge you a low rate to take out a loan from your whole life policy, but they'll continue to pay interest and dividends. So, your account continues to earn interest even when you've used some of the money to pay off other expenses.
Frequently Asked Questions On Paid-Up Additional Insurance
Now that we've covered how paid-up additional insurance can increase your policy's cash value and death benefit, let's go over some of the other details. Here are answers to some of the most frequently asked questions about buying paid-up additions.
What are mutual insurance companies?
Mutual insurance companies are life insurance companies where policyholders are considered part owners. They divide up their net profits and distribute these profits to their policy owners in the form of dividends. This money can be used to pay for future premiums or to buy paid-up additions.
How are my dividends determined?
The rate of dividends that will be given to you will vary depending on the insurance company. In most cases, your cut will depend on the amount of cash value you have inside the policy as well as the amount of the death benefit guaranteed to you by the insurer.
With a paid-up additional policy, your cash value and the death benefit are larger, so your future dividends will also be bigger.
What are dividend scales?
Dividend scales refer to the dividend payable in the current year, plus dividends that the life insurance company will pay to you in the future. If there's an event that significantly affects the company's financial performance, the company adjusts its projections and produces a new dividend scale.
Will loans affect my dividends?
Taking out loans against your life insurance policy may lower the dividends you'll receive. That's because the life insurance company could not invest the full cash value by loaning you a portion of it.
Are paid-up additions taxable?
Paid-up additions are not taxable. Its cash value grows tax-deferred, and its death benefit can be withdrawn free of tax. That's because it's considered a mini whole life policy by itself.
What is reduced paid-up insurance?
Those who have a whole life insurance policy but no longer want to pay premiums can convert their policies to paid-up status by lowering the death benefit. This is different from getting a paid-up additions rider.
Can I surrender my paid-up additions?
Yes, you can surrender paid-up additions and receive their cash value. That way, you don't have to surrender your entire life insurance policy and lose your entire coverage.
The benefits of buying a whole life insurance policy don't end with giving your family financial protection after your death. If you buy paid-up insurance additions on top of your original policy, you'll be able to build cash value, earn more interest, and increase your wealth.
Purchasing dividend-paying paid-up additions can be complicated, so it's best to consult a knowledgeable financial adviser. At Wesley Insurance, LLC, we have a trustworthy and dependable team that can help you decide if this is a good investment option for you.