Needs change as we age, and it's beneficial to have a life insurance policy that can change with them. If you're getting older, you may have premiums that are hard to pay or coverage that doesn't suit your situation anymore.
While you might need a change, it's also hard to sacrifice a plan when you've been paying for it for so long. It feels like a lot of hard work and investment goes to waste.
If you've had your plan for some time, you may be able to keep benefits without having to continue payments. It's called paid-up life insurance, and it's a valuable option both for individuals looking to maximize their investments and those trying to manage their finances.
The Two Forms of Paid-Up Life Insurance Policies
A paid-up life insurance policy is an insurance option that retains a death benefit but no longer requires you to make payments. It is exclusive to whole life insurance plans. Unlike term life insurance plans, whole life has a savings component that can allow policyholders to continue meeting the premium requirements without paying out of their own pockets.
A whole life plan is designed to last your entire life. Premiums are higher than those for term life plans, but they remain level until you pass away, even as your health declines.
Although many last an indefinite amount of time, some whole life policies expire when you reach age 100. You may have the option to extend your coverage, or your insurance company may simply close out your plan. It's crucial to understand age limits when shopping plans, especially if you don't think your death benefit needs will change.
Whole Life Earnings and Paid-Up Insurance
Another reason monthly payments are higher in whole life plans is only a portion goes to premiums. Some of it goes to a cash value component, a sort of savings account that builds up interest as you continue to pay into it.
The fixed interest rate of return on cash value is generally low. Still, it's a beneficial backup tax-free wealth generator if you have maxed out your other investments, such as RRSP's.
Some whole life plans supply dividends along with cash value. When an insurer makes a profit, they give policyholders a portion of the funds.
Dividends are dependent on company performance, so there's no guarantee that you'll always get a return. Insurance companies pay out dividends annually.
Between cash value and dividends, whole life policyholders can eventually build up a substantial amount of wealth. Earnings are living benefits that policyholders can withdraw, take tax-free loans against, or use to pay premiums. That last function is the essence of how a paid-up option works.
There are two forms of paid-up life insurance — paid-up additions and paid-up status. In both types, you can use your accrued earnings to pay for a life insurance plan.
Paid-up additions are options on whole life policies that allow you to buy extra insurance with your earnings. It's a smaller sub-policy that increases your death benefits, cash value, and dividends of your combined plans at once. The death benefit and cash value are much less than the original policy.
You can buy a paid-up addition under two circumstances:
- You have a participating whole life insurance plan through a mutual insurance company that issues dividends
- You have a paid-up addition rider on your whole life policy
While these policies still earn dividends and cash value, the premiums are paid in a single payment at the start of the plan. They build cash value along with the original policy, compounding the return for the policyholder and increasing their earnings at a much faster rate.
Understanding Paid-Up Additions
Policies that offer a paid-up option will have higher premiums and lower cash value at the outset. Many policies let you buy an addition with cash. Once you earn enough in dividends after several years, you can purchase a paid-up addition with no out-of-pocket expenses.
When you purchase a paid-up addition, you gain an additional death benefit and a dollar-for-dollar injection of cash value. For instance, if you get a whole life policy and buy an additional $4,000 in paid-up additions, you'll get $4,000 in cash value and a small death benefit on top.
Over time, you can continue to add more paid-up additions to continue increasing your investment growth. Each addition gives you more cash value that earns interest, as well as an expanding death benefit for your family. You also increase the dividends you receive each year because you own a greater stake in the company as your policy's overall value increases.
With a paid-up addition, you can borrow money against the addition or surrender it to receive funds without affecting your original whole life policy. It gives the policyholder more financial freedom in how they use their earnings, and they get a powerful boost in growth potential with each addition they buy.
A paid-up addition is a paid-in-full mini-policy, but you still make premium payments on your initial whole life plan. By contrast, paid-up status means that your life insurance policy is open, but you don't have to make any more premium payments.
Paid-up status is an option on whole life insurance policies that you can use once you have built up sufficient cash value. Depending on how you reach paid-up status, your benefits may change.
Understanding Paid-Up Status
You can reach paid-up status in several ways, which the terms of your whole life policy will clarify.
Some policies have you pay all of your premiums within a specific time. You may have the option to pay off a whole life insurance plan over a certain number of years, by a certain age, or even as one lump sum premium payment.
For instance, you may get a "10 pay policy" for $100,000 that you will pay off in 10 years. You'll then have a $100,000 death benefit for the rest of your life.
In other instances, you may decide to cut your payment period short and opt for reduced paid-up insurance. The option is usually available after you've paid at least three years' worth of premiums.
The death benefit goes down based on how much cash value you have saved to support it. So the longer you go before converting to paid-up status, the more you will have as a death benefit.
For instance, when you have $50,000 in cash value saved in a $200,000 plan, your death benefit will lower to $50,000. You'll then have that death benefit for the rest of your life. If you borrow or withdraw money from your cash value after the plan is paid up, the death benefit will still go down by that amount.
Before resorting to a reduced paid-up status, it's critical to understand everything you're giving up. You may have essential riders in your policy that you might forfeit by converting to paid-up status.
One final option is to pay premiums with the cash value you have earned. It retains the original benefit, and although it isn't technically paid up, it keeps you from having to make premium payments. If the cash value doesn't accumulate fast enough, you may have to resume payments.
The Benefits of a Paid-Up Life Insurance Policy
When you have a paid-up additions rider as part of your policy, you won't need to undergo a medical exam to use a paid-up addition in the future. That can be a huge benefit to an individual whose health declined since they opened their original policy. Your premiums will be higher relative to the death benefit than the original policy, however, as your insurer will take your age into account when you initiate the addition.
Although you won't need a medical exam to use paid-up additions when you have the rider, it's critical to pay your premiums to maintain it. Some insurance companies offer flexibility with how much you pay to fund the addition, while others require a consistent amount each year.
If you don't meet your premium requirements to fund the rider, your insurer may revoke it. Even though you didn't need a medical exam when you added the rider initially, you may need to go through that underwriting if you want to reapply for paid-up additions.
Paid-up additions give you fuel to use cash value interest and dividends to pay for retirement. They're excellent investments when you're young and want to accumulate cash value as fast as possible. Premiums are lower when you open an addition earlier because of your age, so a greater percentage of your payments goes toward tax-advantaged growth.
With an accumulating cash value and death benefit with each addition, your dividends increase considerably as insurers base them on the cash and face value of your plan.
Paid-up status is beneficial for individuals who don't want to surrender their policy but also can't make payments. Converting to paid-up status gives them peace of mind that the policy is still in force and their beneficiaries will get the greatest benefit possible. And if you have a participating plan, you can still earn dividends even after the policy is paid up.
Letting your policy lapse is one of the worst mistakes you can make in managing life insurance. By converting to paid-up status, you ensure that the years of premium payments still work for your benefit.
Example of a Paid-Up Life Insurance Policy
A 40-year-old man buys a whole life insurance policy with a premium of $1,500 and a $100,000 death benefit. When he opens the policy, he puts $2,000 toward a paid-up additions rider. He then gets $2,000 in cash value and $10,000 on top of his initial benefit.
Over time, the cash value in his policy and paid-up addition accumulate interest, and dividends are paid out for the overall value of both.
When someone converts to paid-up status, they eliminate their premium payments either temporarily or permanently. If someone has a $100,000 plan and $100,000 in cash value earned, they can convert to paid-up status and let their cash value pay for the premiums. But in the event, the investment doesn't perform well, they may need to pick their payments back up in the future.
How to Know If Your Life Insurance Policy Has a Paid-Up Option
Paid-up status and paid-up additions are only available with whole life policies. If you plan to use a rider, you'll usually set those up when you open your whole life policy. You may be able to set them up later, but your rates will usually go up, as the insurer has to assess your age and health.
Only mutual insurance providers pay dividends, so they are the only ones who can offer a paid-up addition with those funds. No matter who services your whole life plan, it's crucial to clarify how you can purchase paid-up additions both at the time you start the plan and years down the line.
Is Paid-Up Life Insurance the Right Choice for You?
Paid-up life insurance is an incredible opportunity for people that need flexibility or want to maximize their wealth. Paid-up additions can give you an immediate surge of interest-bearing funds, setting you up for a more fruitful retirement. Meanwhile, paid-up status can provide valuable assurance if you have trouble keeping up with payments in your later years.
Although it can be extremely useful for the right person, paid-up life insurance is not for everyone. It's a complex insurance feature that can vary greatly from one insurance company to the next. If you are interested in learning how paid-up insurance can benefit you and your family, contact our experts at Insurdinary today.