How Does Paid Up Life Insurance Work?
Paid-up life insurance is a policy in which you’ve paid enough money so that no additional premium payments are required. Even though payments are no longer necessary, the coverage will remain in effect for the rest of your life, the cash value continues to grow, the death benefit is locked in, and if you die, the insurer will pay out the full death benefit.
In nearly every case, only whole life insurance policies can become “paid up”. Term policies (except ROP term) will never be paid up.
A whole life policy can become paid up in one of three ways:
- After paying premiums for a specific period, such as 10 or 20 years.
- Paying a single lump sum fee.
- Using the policy’s accumulated cash value.
Ways A Whole Life Insurance Can Become Paid Up
It’s critical to understand that whole life insurance, by default, does not become paid up. You must be intentional about getting a paid-up policy. For example, if you tell an insurance company that you want a whole life policy, the default option presented will likely be one that does not become paid up.
Below is a breakdown of the three ways a policy can become paid up.
Limited-pay
As the name implies, you pay for a specified period of time, and then the policy becomes paid up. How long it takes for a whole life policy to become paid up depends on which one you choose. Here are the most common options:
- 7 Pay: Premiums last for precisely 84 months to reach the paid-up status.
- 10 Pay: Premiums last for precisely 120 months to reach the paid-up status.
- 20 Pay: Premiums last for precisely 240 months to reach the paid-up status.
- Paid up at age 65: You’ll pay premiums until you reach age 65 to get the paid-up status.
- Paid up at age 80: You’ll pay premiums until you reach age 80 to get the paid-up status.
The shorter the pay period is, the higher the cost will be. Also, keep in mind that every company has different offerings. Some don’t offer any limited-pay life insurance policies, while others may have multiple to choose from.
Lastly, you cannot convert a non-limited-pay whole life policy to a limited-pay one. From the very start, you must apply for a limited pay policy for it to reach paid-up status one day.
Single premium
With a single-premium whole life policy, you make a lump-sum payment at the beginning of the policy, which makes it paid up immediately. Expect this to be a substantial payment.
Reduced paid-up option
This is a standard non-forfeiture option present on nearly every whole life policy. It converts the policy’s current cash value into a reduced paid-up amount of life insurance. How much coverage you get is based on the total cash value at the time you exercise this option.
For example, if you have $15,000 in cash value, it may result in approximately $25,000 in reduced paid-up life insurance. It’s important to note that a provider will only exercise this conversion at your request.
What Happens After A Life Insurance Policy Becomes Paid Up?
Once a whole life insurance policy reaches the paid up point, you cannot make any subsequent premium payments. Also, the cash value growth considerably decreases, and you can still execute policy loans.
Whenever you die, the insurance company will pay your beneficiaries the guaranteed death benefit.
While it would be incredibly unwise to do so, the policy will still have a cash surrender valueCash Surrender Value
The amount of money refunded to the policyowner upon cancelling (aka "surrendering") the policy. The surrender value is generally equal to the current cash value or very close to it. even once it’s in a paid up status. So if you needed cash in a bind, you could cancel your paid-up policy for its surrender value.
How Much Does Paid Up Life Insurance Cost?
How much paid-up life insurance costs depends on many variables, including but not limited to: age, health, gender, the amount of coverage, lifestyle, type of underwriting (exam vs no exam), and the type of limited pay contract you choose. Below are sample paid-up whole life insurance rates for $100,000 in coverage.
Be Aware Of Modified Endowment Contracts
A modified endowment contract (MEC) is a cash-value life insurance policy that has lost the tax-exempt cash value growth benefit. With a non-MEC policy, cash value grows tax-deferred, and policy loans don’t create taxable income.
If a policy becomes a MEC (there is advance notice), it is irreversible.
A life insurance company will only transform your policy into a modified endowment contract if you pay excess premiums within a short period of time. that exceed the IRS’s limits.
The IRS uses a “seven-pay test” to determine if a policy will become a MEC. Essentially, if you pay too much money within the first seven years, the policy will become a MEC. Your policy (or an illustration) will clearly lay out the maximum amount of money you can pay within the first seven years and not cause a MEC conversion.
Ultimately, if you want a paid-up whole life insurance policy, there will be cash value that accumulates over time. Be sure to check your policy documents to avoid paying too much and triggering a MEC conversion.
What Are Paid Up Additions & How Are They Different Than Paid Up Life Insurance?
Paid-up additions (PUAs) are fully paid up death benefit add-ons to a participating whole life insurance policy. Essentially, the dividends in the policy are used to purchase the additional coverage, thereby increasing the total net death benefit.
The net effect of this feature is a policy with an ever-increasing death benefit without requiring an increase in cost.
How often the policy purchases PUAs varies by company, but it’s usually done annually and executed without your involvement. When you initially apply for a participating whole life policy, you must choose how you want to use the dividends. One option is paid-up additions; the other is to receive a cash payment.
Frequently Asked Questions
A paid up life insurance policy can be cashed out. When you cancel it, the insurer will send you a check for the surrender value.
Paid up term life insurance does not exist because term policies don’t build cash value (except for return of premium term life insurance).
Paid-up life insurance certainly costs more than non-paid-up policies. However, it can be very valuable, as you’d have a policy that lasts forever and requires no further premium payments. This is especially valuable for those in retirement, when their income is fixed and typically lower than when they were working.
First, the death benefit payout to your beneficiaries will not result in a tax liability for them. Beyond that, a paid up life insurance policy will not create a tax burden unless you were to withdraw more cash value than the premiums you’ve paid.
- Nationally licensed life insurance agent with over 16 years of experience.
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Anthony Martin is a nationally licensed insurance expert with over 16 years of experience and has personally served over 10,000 clients with their life insurance needs. He frequently authors entrepreneurial and life insurance content for Forbes, Inc.com, Newsweek, Kiplinger, and Entreprenuer.com. Anthony has been consulted as an expert life insurance source for dozens of high-profile websites such as Forbes, Bankrate, Reuters, Fox Business, CNBC, Investopedia, Insurance.com, Yahoo Finance, and many more.
- Nationally licensed life insurance agent with over 20 years of experience
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Jeff Root is a nationally licensed life insurance expert with over 20 years of experience. He has personally helped over 3000 clients with their life insurance needs. Jeff is a best-selling Amazon author and the managing partner of a highly successful insurance brokerage that manages over 2,500 licensed insurance agents across the USA. He has been a featured life insurance source for prestigious websites such as Forbes, Bloomberg, MarketWatch, Nerdwallet, and many more.
- Nationally licensed life insurance agent with over 15 years of experience
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David Duford is a nationally licensed insurance expert with over 15 years of experience. He has personally helped more than 15,000 clients buy life insurance. David has been featured as an expert source for highly authoritative publications such as A.M. Best and Insurancenewsnet. He also runs one of the largest Youtube channels to help aspiring insurance agents serve their clients better.
- Nationally licensed life insurance agent with over 20 years of experience
- Best selling Amazon author.
Jeff Root is a nationally licensed life insurance expert with over 20 years of experience. He has personally helped over 3000 clients with their life insurance needs. Jeff is a best-selling Amazon author and the managing partner of a highly successful insurance brokerage that manages over 2,500 licensed insurance agents across the USA. He has been a featured life insurance source for prestigious websites such as Forbes, Bloomberg, MarketWatch, Nerdwallet, and many more.
- Nationally licensed life insurance agent with over 15 years of experience
- Best selling Amazon author of five insurance sales books.
David Duford is a nationally licensed insurance expert with over 15 years of experience. He has personally helped more than 15,000 clients buy life insurance. David has been featured as an expert source for highly authoritative publications such as A.M. Best and Insurancenewsnet. He also runs one of the largest Youtube channels to help aspiring insurance agents serve their clients better.
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modified endowment contract. https://www.investopedia.com/terms/m/modified-endowment-contract.asp
