This Paid-Up Additions (PUA) article was updated April 11th, 2020
What is Paid-Up Additional Life Insurance (PUA) inside a Whole Life policy?
PUA Definition: Paid-Up Additions are mini chunks of whole life insurance stacked onto an ordinary whole life policy. However, paid-up additions are completely paid-up in one shot with either a single premium payment into a PUA rider or by electing the dividend option to have dividends purchase paid-up additions, which increase both the guaranteed cash value and guaranteed death benefit of a whole life insurance policy.
After one initial premium load of somewhere between 5%-10% there are zero ongoing mortality charges dragging on a PUA’s cash value growth. This is the power of Paid-Up Additions!
Below we will show you how adding a flexible Paid-Up Additions rider onto an ordinary Whole Life policy can transform it into a good investment vehicle because of the disproportionate amount of PUAs that can be pumped into your policy.
Are Paid-Up Additions Taxable?
Paid-Up Additions are not taxable unlike dividends that accumulate at interest at the insurance company. A PUA’s cash value grows tax-deferred and the death benefit is tax-free since it is technically a miniature whole life insurance policy unto itself.
Keep in mind however, that a paid-up addition must be added onto an existing base whole life policy, hence the word “addition” in PUA. If you buy a single premium whole life policy on its own, you will violate IRS premium thresholds and your single premium whole life insurance policy will become immediately classified as a Modified Endowment Contract (MEC), which loses some of the key tax advantages of ordinary whole life insurance.
Because a paid-up addition is attached to a base whole life policy, you can in many cases pay a single premium into your PUA rider and stay within the IRS thresholds.
In a whole life MEC the underlying paid-up life insurance policy would still function the exact same way as a PUA, except that some of the Roth-like tax advantages afforded to whole life insurance would be revoked by IRS. For instance, with a paid-up MEC you would be taxed on all your growth as soon as you were to take either a withdrawal or loan from your policy.
Conversely, with paid-up additions stacked onto an ordinary base whole life policy, your withdrawals up to your premium basis in the policy plus any loans remain tax-exempt so long as you leave some small amount of your whole life policy as a death benefit.
See how the 2020’s Best Whole Life Insurance Company helps you protect and maintain the tax-sanctuary of life insurance with their unique “overloan protection rider.”
A Paid-Up Addition’s Guaranteed Growth & Guaranteed Death Benefit
Since a PUA is just like a miniature Whole Life policy, only with no further premiums due, let’s take a step back and look at how Whole Life itself works. This excerpt below from our article “Whole Life’s Guaranteed Growth and 4 Ways to Accelerate It” will help you understand the power of a Paid-Up Addition.
“At its core, a Whole Life insurance policy is actuarially designed so that its cash value will equal its death benefit either immediately when the insured dies or at age 120, whichever comes first…Even though you may not intend to reach age 120, your Whole Life policy’s cash value will climb on that trajectory toward your death benefit each and every year on a guaranteed basis…Be very clear that this is the core growth engine of a whole life policy…It is unfettered by prevailing interest rates, economic downturns, the company’s profitability, and so on.”
See how the guaranteed cash value growth steadily converges on the $1,000,000 death benefit even though this particular policy is Whole Life paid-up at age 65. The CV=DB at age 120 (or sooner if he dies prior).
The graphic above (also from the “Guaranteed Growth” article) depicts a $1,000,000 Whole Life insurance policy written on a 38-year-old with a guaranteed level $13,840 annual premium set to be paid for 28 years so that the policy becomes contractually paid-up life insurance at age 65 rather than the normal age 99 or 100.
Rather than even paying that accelerated premium schedule over 28 years like the image above, a PUA is completely paid up with one single premium payment. The single premium of a paid up addition is essentially the present value of a lifetime’s worth of smaller payments spread over the life of the policy.
This accelerated premium payment of a paid-up addition means you will have more money working for you sooner earning Whole Life’s guaranteed interest crediting. Because of this, a PUA’s guaranteed growth curve is even more efficient than what is depicted in the graphic.
You get the basic idea though.
Paid-Up Additions are a Good Idea Because They Give You a Bigger Share of any Future Dividend Pools
Part of what makes Whole Life a favorable investment is that it’s the type of insurance policy that pays dividends to policyowners. This is because a mutual insurance company is owned by its policyholders. Exactly how dividends are credited to a policy will vary between different life insurance companies. Regardless, your cut of a mutual insurance company’s dividend pool often depends on both the amount of your cash value you have inside the policy as well as the amount of your permanent death benefit your Whole Life policy supports (including Paid-Up Additional life insurance).
You can purchase a PUA by having a flexible Paid-Up Additions rider and making additional premium payments or by electing your Whole Life dividend option to purchase PUA’s. Either way, Paid-Up Additional life insurance increases both your policy’s cash value and the permanent death benefit.
Therefore, these PUAs will increase your share of any future dividend pools declared by your mutual insurance company. If you use those additional dividends to purchase even more PUAs, you obviously continue to increase your policy’s cash value and paid-up life insurance, which increases your share of the next declared dividend pool, and so on.
You can imagine how this cycle can create an exponential compounding effect, especially when you maximize your PUA payments.
PUAs Actually Raise the Bar of Guaranteed Cash Value Growth Through Paid-Up Life Insurance
Remember how the cash value of a paid-up policy must equal its death benefit by age 120, and how this contractual constant sets the trajectory of your guaranteed cash value growth?
Since each PUA purchases paid-up life insurance, these little paid-up policies keep stacking upon each other, which essentially raises the death benefit target that your guaranteed cash value must reach. You are layering a foundation with these extra PUA premium payments (as well as dividends elected to purchase paid-up additions) which MUST crawl higher and higher toward a bar set by this paid-up life insurance that continually gets added to the policy.
(The image below is not drawn to exact scale but conceptually represents how stacking Paid-Up Additional life insurance on top of a Whole Life policy increases the death benefit and the trajectory of the guaranteed cash value’s growth curve.)
This effect is exactly why paid-up additions vs. the accumulated dividends are a better dividend option for a Whole Life insurance policy. When you choose to have dividends accumulate at interest, they do earn some declared annual interest rate, which is taxable, vs. adding paid-up addition premium payments to the guaranteed cash value growth, which remains tax sheltered. Also, accumulation at interest also does nothing to increase your death benefit like a PUA does.
Use a Flexible Paid-Up Additions Rider to Buy PUAs as Early and as Often as You Can
A Paid-Up Additions rider allows you to buy PUAs with additional premium over and above the required base premium of an ordinary Whole Life policy. Since these extra premiums go to buy paid-up life insurance, the insured must qualify medically and financially for these expected additions which increase both the cash value and the death benefit.
A flexible Paid-Up Additions rider allows you to be flexible with when and how much of these PUAs you want to buy in the future.
You see, certain mutual insurance companies that offer Whole Life insurance with a Paid-Up Additions rider have a “use it or lose it” policy. If you neglect to pay a certain amount of additional premium in a certain year to fund your PUA rider, many carriers will revoke your right to purchase PUAs in future years. Other life insurance companies make you re-apply and re-qualify medically every so many years to continue funding your paid-up additions rider.
See how 2020’s Best Whole Life Insurance Company allows you to underwrite your entire lifetime’s worth of paid-up additions for their PUA rider unlike any other insurance company.
As you get older, even if you are automatically approved to fund your paid up additions rider, the same amount of PUA premium buys you less paid-up insurance than you got last year. The resulting amount of additional cash value will be the same as the previous year, but it will be propping up less paid-up insurance.
Basically, as you get older your paid-up life insurance costs get higher and higher. To buy the same amount of paid-up life insurance as the year before, you must pay a slightly higher single premium each year you get older. Looking at the paid-up value formula another way, since that single premium has less time to reach its eventual death benefit destination by age 120, you must essentially front-load it with more premium dollars from the jump.
So the younger you can start a policy designed to allow for maximum PUAs, the more paid-up life insurance you bolt onto your Whole Life insurance policy, which as you learned:
- Increases your guaranteed cash value growth
- And increases your cut of future dividend pools
This is also why most people elect to purchase Paid-Up Additional insurance with their dividend option as long as they possibly can. Eventually, as you reach retirement age and you need income, it may make sense to instead have your dividends paid out to you in cash rather than purchase paid-up additional insurance at these older ages.
However, in order to create plump dividends to spend in retirement, you will want to have your early whole life dividends roll back into your policy to purchase paid-up additions.
Adding a Term Insurance Rider to a Whole Life Insurance Policy to Maximize your PUA Rider
- Remember how the IRS limits the amount of premium per the amount of total death benefit you have?
- Remember that if you don’t have enough total death benefit the IRS can revoke certain key tax benefits?
- Remember that ideally you want to minimize your base whole life policy and maximize paid-up additions?
Blending a term insurance rider onto your base whole life policy is a way to maintain all the proper death benefit ratios while allowing you to stuff a disproportionate amount of PUA premium into your policy earlier than you would normally be allowed to. With a term rider you’re essentially creating a cavity so you can disproportionately increase the amount Paid-Up Additions that you can stuff into a Whole Life policy.
Accelerating this early growth by maximizing the amount of paid-up additional life insurance that will continue compounding into the future.
Just to be clear, this term insurance rider on its own does nothing to enhance wealth building inside a Whole Life policy. In fact, it will even add some additional mortality charges. However, these charges are often a very nominal amount considering the amount of temporary death benefit it props up, which gives you loads of PUA capacity that you otherwise wouldn’t have with just a PUA rider added to an ordinary Whole Life insurance policy.
Learn how 2020’s Best Whole Life Insurance Company combines a flexible PUA rider with either a flat or increasing term rider to accommodate concentrated early PUAs or a extended ongoing paid-up additions. Keep in mind that the image is not necessarily drawn to scale given your age and health rating, but you should definitely find out what a Whole Life insurance policy designed with maximum PUA capacity could look like for you.
Paid-Up Additions when Becoming Your Own Banker
If you have not heard of this phenomenon of using Whole Life insurance to become your own banker you can check out our article 5 Steps to Be Your Bank with Whole Life Insurance.
When it comes to using Whole Life to be your own bank, paid-up additions are definitely a good idea. The idea is to get as much accessible cash value working in the policy as quickly as possible. That way you have enough equity in the policy to borrow against it for outside investments or major expenditures, while still having your entire cash value growing for you while propping up paid-up life insurance.
I understand that double-dipping using Whole Life insurance to become your own banker may sound a little too good to be true. Because of this, we wrote an article spelling out The Top 4 Myths Behind Becoming Your Own Banker.
Many agents are reluctant to illustrate Whole Life insurance with a term insurance rider in conjunction with a flexible paid-up additions rider because doing so drastically reduces their commissions. The Banking Truths Team has no qualms whatsoever about offering this type of policy since we make it up in volume. Our independent agents are adept at designing policies from the top mutual companies in this fashion.
You can have us get started designing a custom policy to hold maximum PUAs for you. Simply use the green button at very the bottom of this page to input your age, estimated health rating, as well as the time you want to connect with us via screen-sharing to have us run some different company’s PUA calculators and explore the optimal whole insurance policy designs for you.
John “Hutch” Hutchinson
ChFC®, CLU®, EA, AEP®, CExPs®