Reduced Paid-Up Life Insurance | Bankrate

What happens to a life insurance policy if you are no longer able to, or no longer want to, pay your premiums? This depends partly on the type of policy you have. If you have a whole life insurance policy, you may be able to make use of a tactic called reduced paid-up life insurance. Essentially, you exchange your policy’s value for a fully paid-up whole life policy with a reduced death benefit. Bankrate’s insurance editorial team did a deep dive into the research on this type of policy, so you can decide if this option is the right one for you. 

What is reduced paid-up life insurance?

Reduced paid-up life insurance is generally available for whole life insurance policies. Whole life is a type of permanent insurance that is designed to last your entire life and provide a death benefit for your named beneficiaries when you pass away. As you pay your premiums, your policy accumulates cash value. If you decide you no longer want the responsibility of paying premiums, you can opt to take the cash surrender value (CSV) and use it to purchase a fully paid-up policy. The death benefit of the new whole life policy is whatever the CSV can purchase as a single premium based on your age. 

You would need to confirm eligibility for the reduced paid-up insurance coverage option since most life insurance companies require the policy to be a certain number of years old. The reduced paid-up option is not available with term life insurance policies since those types of policies do not build any cash value.

How do life insurance companies calculate the reduced value of your policy?

Calculating the reduced death benefit is a little complex. Your insurer will first look at the net cash value of the policy. Your policy’s cash value builds up over time as you pay into the account, and you can borrow against it if needed. To get the net cash value, your insurance company will take the cash value amount and subtract any loans you’ve taken from it and haven’t paid back. They will then add in any interest or dividends that have accumulated to arrive at a final net cash value. 

The amount of paid-up life insurance available is the amount that can be purchased at the insured’s current age with the net cash value. The amount will be purchased as a single-net premium, thus the policy being paid off from the start.

For example, let’s say you have built up $50,000 in cash value in your policy to date. A year ago, you took out a loan from that cash value and have a balance of $10,000. That reduces your cash value to $40,000. You’ve also earned $2,000 in dividends on the policy. Therefore, you have a net cash value of $42,000. You take that $42,000 and buy a $100,000 whole life policy that doesn’t require any more payments. (This is referred to as a single-premium whole life policy.) It will remain in force for the remainder of your life and provide your beneficiary $100,000 when you pass away.

When is reduced paid-up life insurance a good option?

Choosing to use the reduced paid-up life insurance option may be a good choice for those struggling to make the annual premium payments. If the cost of your whole life policy, for instance, is becoming more of a burden, then it could be best to convert. It’s probably a better move to convert the policy than risk a policy lapse, which could result in policy termination.

It may also be a wise financial move to keep the policy in place if you want to keep the death benefit along with the tax benefits this type of policy may provide. If you’re not sure if reduced paid-up life insurance is right for you, consider speaking with a Certified Financial Planner (CFP), Chartered Life Underwriter (CLU) or licensed life insurance agent.

When is reduced paid-up life insurance not a good option?

Converting to this policy option may not work for every policyholder. If your current whole life policy includes several riders you are dependent on for financial protection, then you should be aware these riders will be canceled upon conversion.

For example, if your whole life policy currently includes a disability rider that would pay out monthly if you were to become disabled, then you would lose this rider when converting to a reduced paid-up policy. You would no longer be able to depend on this income if you were unable to work. Again, speaking with a financial planner or life insurance agent to determine the best move for you could be helpful.

Other nonforfeiture options for life insurance

Other nonforfeiture options for life insurance are available to policyholders besides reduced paid-up life insurance. It is important to review the availability of these options with your life insurance company since not all options are available from each carrier. Nonforfeiture means you are canceling or converting your policy but still receiving some value from it.

Cash surrender value

Cash surrender value is where the life insurance company pays the cash value to the policyholder in one lump sum. Cash surrender value cancels the policy, and it cannot be reinstated. If your policy has been in force less than 10 years, there will likely be a surrender fee.

Extended term insurance

We talked about net cash value above, which is the amount of the policy’s cash value minus any money you’ve taken out of it as a loan, and plus any dividends. If you decide to transition to an extended term insurance policy, that amount can also serve as the basis for your policy length for a term policy. The death benefit will be the same as the original whole life policy, and the term will be determined by what can be purchased with this net cash value. 

What are paid-up additions for life insurance?

Generally available only for whole life insurance policies, paid-up additions, or PUA, are small amounts of additional coverage that you may purchase with earned dividends which increase your death benefit and cash value. They are basically mini-policies that can be purchased using your policy’s dividends. Since this additional coverage is paid all at once through your dividends, it does not mean you will need to make a regular premium payment. 

Frequently asked questions

• What is the best life insurance company?
  

  To determine the best life insurance company, it is critical to compare several options to see which one best suits your financial situation and needs. Comparing the financial stability of a company, reading customer reviews, reviewing the life insurance coverage and options and obtaining quotes is an effective method for finding the best life insurance company. Keep in mind that rates for life insurance typically do not vary as much for the same coverage and limits as other types of insurance, but it could still be helpful to collect several quotes and compare to see which company offers the right policy and price for you.

• Who needs life insurance?
  

  Life insurance can provide financial protection for many people in different situations. In many ways, the point of life insurance is to help protect against the risk of the unknown — to provide a financial safety net in case the worst should occur. Some of the common reasons people consider life insurance include when their partner or family depends on their income, when there are young children to consider, if there are mortgages to consider or to protect family and business partners from debt. Whatever your reasons for wanting a life insurance policy, you may want to consider speaking with a licensed agent or Chartered Life Underwriter, who can help you decide what type of life insurance (and how much) is right for you.