To purchase a life insurance policy and keep it in force, you have to pay your premiums on time. However, that doesn’t necessarily mean you need to continue making payments for the entire time your policy provides coverage. Instead, it’s possible to pay your premiums off early so you have a paid-up life insurance policy. With a fully paid policy, you don’t have to worry about making premium payments again.
How Does Paid-Up Life Insurance Work?
A paid-up insurance policy isn’t a distinct type of policy. Instead, it’s any policy where you’ve already paid the required premiums. It remains in force without you needing to make any additional payments.
Term policies can’t be paid up. A paid-up policy must be a permanent policy, such as whole life, that builds cash value. That said, this option isn’t available on every permanent policy. So if it’s something you’re interested in pursuing, carefully read your contract and understand its parameters.
You can fully fund your life insurance policy in a few ways.
Accelerate Your Premium Payments
You may be able to make larger premium payments for a shorter period. This would allow you to fully pay for your policy in a shorter time. However, understand that the shorter your payment period is, the higher each payment. That could strain your budget, so make sure you can afford it before choosing this route.
When It’s a Good Option
This option might make sense if you have the ability to pay and want to get the payments behind you.
Opt for a Reduced Paid-Up Life Insurance Policy
If you already own a policy and don’t want to continue making regular premium payments for whatever reason, you could consider a reduced paid-up death benefit. With this option, you don’t forfeit the policy and withdraw the cash. Instead, you allow your policy’s cash value to convert into a fully paid death benefit. This can significantly reduce the amount your beneficiaries receive, but it may be better than letting the policy lapse altogether.
When It’s a Good Option
If you can’t afford to continue making payments, opting for a reduced paid-up life insurance policy offers an alternative to canceling the policy and allows your coverage to remain in force.
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Purchase Paid-Up Additions
If your life insurance policy pays dividends, you may be able to use them to purchase paid-up additions. As the name suggests, paid-up additions are additional increases in the death benefit that don’t require continued payments.
Instead of taking your dividend in cash, you direct the insurance company to add a fully funded amount to your death benefit. Because a portion of each premium payment in a permanent policy goes toward the cash value, receiving your dividends as paid-up additions can increase your cash balance too.
When It’s a Good Option
Paid-up additions may be a good option if you want to increase your death benefit without raising your monthly premium or going through the underwriting process again. It can be especially helpful if you want to boost your coverage when you’re older or have developed a health condition that might prevent you from qualifying.
Benefits of Paid-Up Life Insurance Policies
Fully funding your life insurance policy can provide a few benefits that you can enjoy immediately and into the future.
No Risk of Policy Lapse
You don’t have to worry about the policy lapsing due to nonpayment. You’ll continue to have life insurance coverage unless you surrender the policy.
Boosts the Policy’s Cash Value
Fully paid life insurance builds cash value more quickly. That larger cash value can also continue to grow through additional compound growth.
Potential Drawbacks of Fully Paid Life Insurance
Paid-up policies can have some downsides.
Loss of Riders
If you allow your contract to convert to a reduced paid-up policy, you may lose any riders associated with your contract. This is because you’ll technically have a new coverage plan under the new policy, with different terms.
Subject to Opportunity Cost
Using your dividends to purchase paid-up additions involves an opportunity cost because that money would otherwise be paid to you in cash. Before making this move, consider what else you could do with the money, such as paying down debt, investing it in a retirement account, or saving for a child’s college.
Risk of Policy Becoming a MEC
Because life insurance policies’ cash value can grow on a tax-advantaged basis, Congress set limits to prevent people from using policies as tax shelters. So, if you pay for your policy too quickly—within the first seven years—it could become classified as a modified endowment contract (MEC).
The major downside of your policy becoming a MEC is the difference in tax treatment. Any withdrawals or loans you take come first from the earnings on your cash value. Because these earnings are taxable, your distribution or loan is also taxable. Your cash value is otherwise still tax-deferred, and your beneficiaries still receive a tax-free death benefit.
Is Paid-Up Life Insurance Right for You?
Fully paid life insurance can be a good tool depending on your circumstances and financial goals. It builds cash value quickly and provides you with a permanent death benefit. Depending on how you fund it, fully paid life insurance can also be a good alternative to forfeiting a policy or may allow you to increase your death benefit without additional underwriting.
Insurers and their representatives are not permitted by law to offer tax or legal advice. The general and educational information here supports the sales, marketing or service of insurance policies. Based upon individuals’ particular circumstances and objectives, they should seek specific advice from their own qualified and duly-licensed independent tax or legal advisors.
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