The paid up additions feature of a whole life insurance policy is one of the most powerful components with respect to cash value accumulation. Most whole life products have a paid up additions (PUA) feature, but they can all work a little differently so it's important to note that one company's approach could vary substantially from others.
But before we explain how they work…
What Are Paid Up Additions?
Paid up additions are available through a rider that is added to a whole life insurance policy. The PUA rider allows the policy owner to purchase additional paid-up insurance on their policy. That all sounds very technical, so let's explore what that actually means for you if you're looking at cash value life insurance (whole life in particular) and trying to decide if it's the right fit.
The PUA rider is the mechanism used to place additional money into a participating whole life insurance policy to increase policy cash value performance. Every dollar of premium that is allocated to the paid up additions rider creates a small paid up insurance policy that has its very own cash value that is created immediately. In general, whole life insurance policies that have a substantial portion of the total premium allocated to paid up additions will outperform those that do not take advantage of PUAs.
There are also various paid-up additions options available from each insurance company. It may all seem complicated but hang in there, we're gonna explain it in multiple ways and provide examples to illustrate how it works. We want to help everyone understand paid-up additions and their application to life insurance policies.
8 Things to Understand About Paid Up Additions
It makes perfect sense to dedicate some time to the discussion of paid-up additions and their role in cash value life insurance. You’ll find them under a few different names (additional insurance rider, enricher rider, enhanced paid-up additions, etc.), but it all means the same thing.
The important thing to understand is PUAs and the PUA rider are critical for creating a cash-rich policy. Today we'll help you understand how they function inside a well-designed policy that helps you achieve your goal of focusing on maximum cash value build-up.
With nearly two decades of working in the life insurance industry and having sold hundreds of whole life insurance policies over the time frame, we have actual, real-world experience with all of this. In fact, the Insurance Pro Blog itself is the longest continuously running financial blog committed to information on life insurance.
So when we sat down to figure out how best to explain PUAs, we came up with 8 key aspects you must understand to squeeze the most value from them
The 8 key things are:
- It's a Dividend Option
- It's also a Rider
- PUAs have Immediate Cash Value
- They have their own Death Benefit
- They Earn Dividends
- Have their own Load Fees
- Can Vary a lot from Company to Company
- PUAs are the Mechanism used for 1035 Exchanges for Whole Life Insurance
Using the Dividend Option to Purchase PUAs
A lot of whole life insurance policyholders have experience with paid-up additions but most may not realize this. One of the most common dividend options used for whole life policies is the option to purchase paid-up additions. This means the insurance company takes the dividend earned on a whole life policy and uses these funds to purchase the additions for the policyholders.
For those seeking the fastest accumulation of whole life insurance cash values, there is no better option than purchasing paid up additions. I'll explain later in this blog post why that is.
For most insurers, the dividend option to purchase paid up additions is the default option. So if the policyholder or agent do not elect a different option, the life insurer will automatically assume this option
The PUA Rider
In addition to being a dividend option, paid up additions can also be a rider. This means the policyholder can choose to add the PUA feature to his/her policy and elect to make a payment to the policy solely for the purpose of buying PUAs.
This differs from the dividend option to purchase PUA's because now the policyholder is choosing to take external funds and use them t0 purchase the additions. This money does not represent a dividend earned on the whole life policy.
To be clear, many whole life insurance policies afford the ability to both use the PUA dividend option and elect the rider thus allowing the policyholder to both purchase PUAs with their dividends and buy paid up additions directly with additional funds they decide to contribute to the policy.
Have Immediate Cash Value
When someone who owns whole life insurance chooses to buy paid up additions in addition to paying their base whole life insurance premium, they gain an immediate advantage–the paid up additions produce immediate cash value. This cash value functions similarly to the rest of the cash value in the policy. The policyholder can pledge this cash value for a policy loan. Additionally, the policyholder can surrender the paid-up addition and receive its cash value–we sometimes refer to this is “withdrawing” money from a whole life policy.
A dollar used to purchase a paid-up addition, creates a dollar of cash value (minus any fees associated with the paid-up additions, see the fees section below). This creates much faster cash value in the whole life policy versus standard base whole life insurance premium, which can take years to create cash value for the policyholder.
Creates Immediate Death Benefit
Paid-up additions also create an immediate death benefit, and this death benefit is a multiple of the dollars used to purchase the paid-up addition. For example, a dollar used to purchase a paid-up addition might create five dollars in death benefit.
This death benefit is immediately “paid up” (hence the name) and requires no further payments to remain in force. Paid up additions can be thought of as miniature paid-up whole life policies attached to a larger whole life insurance policy. This means the PUA feature (whether it be through the dividend option or an elective rider) augments the total overall death benefit of a whole life insurance policy. Over several years, the PUA feature could create a larger death benefit than originally purchased on the whole life policy.
The amount of death benefit acquired through each paid-up additions purchase depends on the age of the insured. As the insured under the policy ages, the multiple of death benefit created per dollar used to purchase the PUAs declines.
For example, a 30-year-old might receive $8 in death benefit for every $1 used to purchase a paid-up addition whereas a 50-year-old might receive $3 in death benefit for every $1 used to purchase a paid-up addition.
I mentioned earlier that paid up additions can be thought of as miniature paid-up whole life policies. These miniature policies are participating policies, which simply means that they too earn dividends.
The significance of this fact is subtle but substantial. Because PUAs earn dividends, there is a compounding effect that's created by the continual purchase of PUAs. More purchased, means more dividends earned. When dividends themselves go towards the purchase of more PUAs, this creates more PUAs which in turn purchase more paid-up additions, which earn more dividends, which purchase more paid-up additions, and etc.
PUAs usually have a one time fee assessed at purchase. Insurance companies express these fees as a percentage of the purchase amount just like a load fee assessed against a mutual fund.
For example, if the paid-up additions load fee is 10% and a policyholder uses $1,000 to purchase paid-up additions, then the fee is $100. The $100 goes to the insurance company and the policyholder has $900 in immediate cash value created by the paid-up additions. There are no additional ongoing fees for paid-up additions.
Fees can (and usually do) differ depending on the way policyholders purchase paid-up additions. The example above most closely depicts how fees work for paid-up additions purchased through a rider.
The fee charged by insurance companies varies a lot among insurers. It's tempting to compare paid-up additions by load fees and suggest that lower is better. However because most whole life products are issued by insurers with a direct interest in returning profits to policyholders, a higher paid-up additions fee doesn't always mean a lower-performing policy.
Variation Across Insurers is almost Limitless
The exact functionality of the paid-up additions rider varies considerably from one insurer to the next. While most behave pretty straightforwardly concerning the dividend option to purchase paid-up additions, the paid-up additions rider differs greatly among life insurance companies.
Insurers also have a practice of calling the paid-up additions rider different things. Some common names are: additional premium rider, additional paid-up insurance rider, optional permanent protection, enricher rider, and supplemental insurance rider. They all mean and, for the most part, do the same thing.
Some insurers differentiate between a lump sum and scheduled paid-up additions rider. The difference being the former allows a single payment around the outset of the policy while the latter permits ongoing payments several years into the future.
Certain insurers permit a large degree of flexibility in the exact payment of the paid-up additions rider while others require a specific amount be paid each year.
Most insurers impose yearly and/or lifetime limits on the amount of money a policyholder can place into the paid-up additions rider. This limit might be a fixed amount or a multiple of some basis such as the amount of base whole life premium on the policy. Insurers place these limits because they worry about the liability created by the ever-increasing death benefit brought about by paid-up additions.
The Mechanism for a 1035 Exchange
For those seeking to make use of the tax-free 1035 transfer of cash values from one life insurance to a whole life insurance policy, paid-up additions are a required feature of the new whole life product. The paid-up additions rider is the mechanism through which the cash transfer can flow into the new whole life policy. Without a paid-up additions rider, the new whole life policy cannot accept the funds.
The good news is, almost all whole life policies issued in the United States have at least a paid-up additions feature in place to accept 1035 exchange money.
The “Supercharger” Rider
There have been books written about whole life insurance and using your whole life policy as a personal banking system. Those books often make reference to a rider that supercharges the accumulation of cash values in a whole life insurance policy. All of those references are referring to the paid-up additions rider.
The paid-up additions rider is most often used purely as a strategic way to increase the cash value of a whole life insurance policy. While paid-up additions do create additional death benefit, it's rare to come across a circumstance where one uses them purely to increase the death benefit.
Whether a life insurance policy design simply adds a PUA rider on top of a whole life premium or uses term life blending to open up additional funding capacity, the paid-up additions rider is a must for those seeking cash-rich whole life policies.