In order to understand what paid-up additions are on a whole life policy, it’s essential that we first understand what dividends are, since dividends are what purchases the paid-up additions.
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Whole Life Dividends
Whole life insurance policies are a class of what is referred to as “participating policies” because policyowners participate in the profitability of the insurance company by receiving what is called “dividends.”
These payments of the sharing of profits are much the same as a company, such as Apple, pays out dividends each quarter to shareholders of Apple stock.
If dividends are paid out of the life insurance company’s profits, how then are these profits generated?
Life insurance companies generate profits by investing a portion of the insured’s monthly or annual premium in investments, such as stocks and bonds.
Since life insurance companies are committed to paying dividends on whole life and modified whole life policies, they tend to invest in more conservative investments, such as government bonds, or high-quality corporate bonds.
Bear in mind that dividends are not guaranteed, though some insurance companies have paid them every year for over 160 years, including the Great Depression. This is why so many people see cash value life insurance as a dependable way to help accumulate wealth over their lifetime.
It is also important to note that all life insurance policies do not pay dividends, only whole life insurance. Variable Universal Life (VUL), for example, accumulates cash value for its policyowners by investing in a number of different types of investment vehicles, but primarily in the stock market.
Generally, owners of VUL policies are interested in realizing profits that outperform the fixed-income securities marketplace, such as bonds. Variable universal life insurance policies do not pay dividends to policyowners, and may, in fact, generate negative returns if the general stock market performs poorly.
Paid-up additions are additional insurance that a policyowner purchases using their whole life insurance policy dividends. They are available as a rider on the policy, which is selected when a policy is applied for.
In some instances, insurance companies may allow an insured to add paid-up additions to the policy after it has been in force; however, they will have to prove their insurability in most cases.
Using dividends to purchase paid-up additions is beneficial to the policy owner for many reasons, one being that the life insurance is purchased at no out-of-pocket cost.
A $100,000 whole life insurance policy with a $100 per month premium can become a $110,000 policy for the same $100 monthly premium using paid-up additions through the use of dividends.
It should be noted that dividends do not have to be used to purchase paid-up additions to the whole life insurance policy. They can be left to accrue, which allows them to earn interest and compound over time. This will increase the overall cash value of the policy.
However, if left to accrue, the dividend interest is viewed as taxable income and is taxed accordingly. Paid-up additions do not trigger a taxable event for the policy owner.
Paid-Up Additions for a Growing Family
Many individuals purchase life insurance to protect their families in the event of their death. They do this because the loss of their income would be detrimental to the standard of living of the family they left behind. Purchasers of whole life insurance policies often fall into this category and have not only growing families but growing financial obligations as well.
Younger married couples are excellent prospects for life insurance because they have a legitimate need to secure a policy while their rates are lower, and they are in good health. They often have recently married and have not started a family, or are adjusting to life with young children.
They recognize the fact that their income is not growing at the same rate that their grocery and clothing bills are and that if one of the breadwinners were to die, the remaining spouse would be hard-pressed to keep the family living in the lifestyle to which they are accustomed.
Paid-up additions are a very valuable way of lowering the financial risk a growing family faces. By using paid-up additions, the face amount of the policy increases as dividends are applied to the whole life policy.
This provides the family with additional protection as their family grows and additional financial obligations are assumed, such as private schools or a new mortgage.
Paid-up additional life insurance also goes into force without any evidence of insurability. As people grow older, statistics show that they are susceptible to the onset of illnesses such as high blood pressure or diabetes.
This can render them uninsurable as far as the insurance company underwriting is concerned. However, with paid-up additions, these health issues do not affect the increase in the face amount of the policy because of the guaranteed issue feature.
The Downside of Paid-Up Additions
While there are many benefits to a policy having paid-up additions, there is one negative effect they have on a policy, so, are paid-up additions a good idea?
If dividends are left within the cash value of a policy and are allowed to grow and are not used to purchase paid-up additions, the cash value will accumulate considerably faster than if they were used to fund the purchase of additional insurance.
This compounding can lead to a substantial difference in cash value, which can be used later in life as low-interest loans to help fund retirement or pay for medical bills.
Depending upon the age of the insured, when a policy is applied for and issued, paid-up additions can be of great value to a policyowner. Younger insureds tend to value the feature more than those with established incomes and family size.
The important thing is that in both cases, whole life insurance offers the choice of features and benefits that make sense to each individual’s personal situation.
Frequently Asked Questions
What are paid up additions in a life insurance policy?
Paid-up additions are additional insurance that a policy owner purchases using their whole life insurance policy dividends. They are available as a rider on the policy, which is selected when a policy is applied for.
What are whole life insurance dividends?
Whole life insurance policies are a class of what is referred to as “participating policies” because policy owners participate in the profitability of the insurance company by receiving what is called “dividends.” These dividends can be used to buy additional insurance called paid-up additions.
Are there any negatives to purchasing paid-up additions in a whole life insurance policy?
If dividends are left within the cash value of a policy and are allowed to grow and are not used to purchase paid-up additions, the cash value will accumulate considerably faster than if they were used to fund the purchase of additional insurance. This compounding can lead to a substantial difference in cash value, which can be used later in life as low-interest loans to help fund retirement or pay for medical bills.