Whole life insurance is a versatile financial asset. You get the death benefit that usually comes to mind when most people think of life insurance. And you also get whole life’s interest-earning cash value component.
These dual benefits let a single policy serve as both a financial backstop in case of death and a tool for long-term wealth building and retirement planning.
Although whole life usually earns fixed interest and is considered a near-zero-risk asset, individual policy features can lead to widely differing growth potential between policies.
Chief among those features are dividend eligibility and the option to purchase paid-up additional insurance.
In either case, a policyholder can directly increase a whole life policy’s current value, thereby enhancing future interest.
Especially when the two are combined, dividends and paid-up additions can dramatically increase a whole life policy’s capacity for long-term growth.
What are Paid-Up Additions?
Paid-up additions (a/k/a “paid-up additional insurance” or just “PUAs”) are sometimes described as smaller, paid-in-full life insurance policies attached to a larger, primary whole life policy.
A PUA is like a coverage supplement—you’re putting a little more into the policy via life insurance dividends to increase its overall value and long-term potential.
Two types of ways to increase your policy are through paid up additions from dividends and paid-up additions on top of your base premium payment.
A paid-up additions rider is an essential ingredient when designing a whole life policy to use for infinite banking.
Individual paid-up additions are purchased in full with a single premium. Frequently, the premium is paid by applying policyholder dividends issued by mutual life insurance companies.
Increased Cash Value & Death Benefit
Once purchased, each addition permanently increases the policy’s available death benefit, along with an increase in the policy’s current cash value.
Increased policy value derived from a PUA adds to the compounding interest a whole life policy earns and, for participating policies, the potential for future dividends.
Because additions significantly increase a whole life policy’s long-term growth potential, the right to purchase PUAs ordinarily must be acquired by adding a paid-up additions rider (sometimes called an “additional insurance rider”) when a policy is issued.
Reduced Paid Up
Paid-up additions shouldn’t be confused with a similar sounding life insurance term: reduced paid-up (“RPU”) options.
An RPU option is a contractual provision that lets the policyholder opt for a lower coverage amount in exchange for relief from any further premium obligations.
Basically, exercising an RPU option lets you keep a policy intact (with less coverage) if you can’t or don’t want to pay future premiums—but you aren’t ready to surrender the policy outright.
On the other hand, a PUA option lets you invest more into the policy to get more out of it in the future.
Term Life Insurance
Other types of life insurance, including term and universal life, do not include paid up additions.
With term insurance, you get a fixed death benefit that lasts for a period of time. There are no dividends and you do not have the option to make a larger payment to increase your death benefit without first qualifying for additional coverage.
With universal life insurance, you have the flexibility of paying more into your policy to increase your cash value up to a point, but universal life does not pay dividends.
How Do Paid-Up Additions Work?
For the most part, paid-up additions are only available if you have a policy with a PUA rider (which typically requires an additional premium), though some insurers offer policies with built-in PUA options that don’t require an add-on rider.
Paid-up additional life insurance can be purchased through a supplemental, one-time premium payment or by applying dividends issued by mutual life insurance companies toward a PUA.
With some dividend-eligible policies, dividends can be applied toward PUAs even if the policy does not include a PUA rider allowing for purchase of additions through a separate premium.
The specific details of how PUAs work vary between insurers, but the basic idea is usually consistent—you purchase the addition in full, and the policy’s death benefit and cash value are then increased accordingly.
Paid-up additions present an efficient means of enhancing policy value because the value increase is effective immediately upon purchase, and the PUA premium isn’t reduced for a separate underwriting charge, as with ordinary premiums.
Increasing Death Benefit
The exact amount of the death-benefit increase depends on multiple factors, most notably the insured’s age when the PUA is purchased.
Everything else being equal, a younger insured receives a higher death benefit increase when purchasing an addition than an older insured who pays the same amount.
In either case, once the PUA is purchased, the supplemental death benefit is guaranteed for the life of the policy, with no further premiums needed.
If the policy is triggered by the insured’s death, the gross payout to beneficiaries includes the primary policy’s face value plus the amount of any additional insurance purchased through PUAs.
Increased Cash Value
The initial boost to cash value when a PUA is purchased is roughly equal to the premium paid for the addition—though there are sometimes relatively small load fees typically measured as a percentage of the PUA purchase price.
From that point forward, the extra cash value amount derived from the PUA grows (like other cash value) and also enhances the potential for future dividends.
Lower Initial Death Benefit But Higher Cash Value Growth
A PUA-eligible policy starts with a lower death benefit than a comparable policy with no right to buy PUAs.
Over time, though, a policy with consistently exercised PUA options ends up with a death benefit that is notably higher than the policy’s face value when it was issued.
And cash-value accumulation handily outpaces a non-PUA policy if additions are purchased regularly.
Dividends and Paid-Up Additions
Not all whole life policies earn dividends, but for those that do, paid-up additions and dividends make an excellent combination.
Mutual Insurance Companies
For the most part, participating whole life policies issued by mutual life insurance companies are the only policies eligible for dividends.
Mutual insurers are formally owned by their policyholders rather than shareholders. And a dividend is basically a small share of the company’s annual net profits.
Life Insurance Dividends
Dividends are never guaranteed. Each year, a mutual insurer’s board of directors and officers decide whether to pay dividends and, if so, how much to pay.
However, some companies pay them like clockwork—a reputation for generous and consistent dividend payments is a major marketing advantage.
A few mutual insurers have even paid dividends every year for over a hundred years.
When an insurance company announces a dividend, eligible policyholders have multiple options.
You can simply accept the dividend in cash and get a check from the company.
Or, you can apply it toward future premiums or tell the insurer to hold the money in a separate interest-earning account.
But, for long-term growth, the best option is usually to invest the dividend back into the policy by using it to purchase a paid-up addition.
Paid Up Additions = Greater Growth
Once a PUA is in place, the addition itself become eligible for future dividends.
So, when you apply a dividend toward a PUA, you increase future dividend potential.
Then, those larger future dividends can, in turn, be applied toward more PUAs, which likewise become eligible for future dividends.
In this way, consistent application of dividends toward PUAs maximizes a whole life policy’s capacity for growth.
If you purchase a policy from a company with a strong track record for dividends and consistently put the dividends toward additions, the aggregate increase in policy value over time compared to a policy without a PUA rider (or that’s not eligible for dividends) can be dramatic.
Paid-Up Additions Rider
As noted above, there are essentially two ways to obtain PUAs: through dividends and through separate premium payments authorized under a PUA rider.
PUA riders go by a variety of names, depending on the company. Additional Insurance Rider, Policy Enhancement Rider, or Paid-Up Supplemental Insurance Rider (and plenty of other names) can all refer to a PUA rider.
Along with the varying nomenclature, insurance companies can also differ in how their PUA riders function. In some cases, purchase of PUAs is entirely at the policyholder’s discretion. You have the right to purchase additions but are not required to.
Other policies set a mandatory minimum purchase amount per year. There’s often a maximum annual purchase amount, too—or a maximum aggregate amount over the duration of the policy.
The cost of purchasing a PUA rider can be built into the policy’s fixed premium and spread out over the life of the policy. Or it might be paid upfront or through annual policy charges.
Over a whole life policy’s long-term time horizon, a PUA rider significantly adds to the policy’s growth potential. However, the rider only provides real value if the right to purchase additions is consistently exercised.
A policyholder who buys a PUA rider and then never uses it—or only uses it once in a blue moon—would usually be better served by a policy without a PUA rider.
Advantages of Paid-Up Additions
As you get older, life insurance becomes increasingly expensive and harder to come by. A paid-up additions rider essentially grants a policyholder the right to purchase greater coverage in the future without any underwriting requirements or risk of rejection.
That means that, when the policy’s death benefit is triggered, the named beneficiary will receive a larger, income-tax-free payment.
The contractual right to increase a policy’s death benefit alone offers genuine value. If you need greater coverage in the future, a PUA rider lets you get it, even if you might not otherwise be eligible.
With that said, though, the more common motivation for purchasing paid-up additions is that they directly increase the policy’s current cash value. And the increased current cash value from a PUA expands future earning potential multi-dimensionally.
First, because cash value earns compound interest, an immediate increase in cash value increases a policy’s future interest-earning capacity. Perhaps more importantly, because insurers use current cash value (including value within PUAs) when calculating future dividends, PUAs also lead to larger future dividends.
Paid-up additions—whether purchased using dividends or supplemental premiums—are themselves eligible for future dividends.
If those future larger dividends are then applied toward more PUAs, a policy’s capacity to earn interest and receive dividends increases even more.
Whole life insurance policies are designed to work over an extended time horizon—over a twenty or thirty-year period, the snowballing dividends and growth can result in impressive returns.
The Value of Cash Value
A whole life policy’s cash value is not just a theoretical number. While an insured is still living, cash value can be tapped through partial withdrawals, policy loans, or an outright policy surrender.
If a policyholder elects to surrender a whole life policy, previously purchased additions increase the size of the check paid by the insurance company.
The ability to considerably expand eventual cash surrender value makes PUAs highly useful for policies purchased as part of a retirement plan.
A whole life policy’s growth—whether in the form of ordinary interest, dividends, or paid-up additions—is tax-deferred.
A policyholder does not owe income tax on any of the growth stored in a policy until the money is actually withdrawn.
Even then, the amount that qualifies as taxable income is limited to the amount withdrawn in excess of the premiums paid into the policy.
Of course, if the policy value ends up being paid out as a death benefit to the beneficiary, it won’t count as taxable income at all.
In either case, paid-up additions provide a tax-advantaged means of long-term wealth building.