The simple definition of paid-up additions is reinvestment of dividends. How does it work? Mutual insurance companies manage and invest money. These investments of course generate yields. In a publicly traded company, these yields are paid out as dividends to shareholders. They can be paid out annually, quarterly or even monthly. This depends on how the company is structured. As we already mentioned in another article, in mutual companies these dividends go to policy owners. Principles of dividends, investing and reinvesting, discussed here, apply to cash bearing policies only. These include various products in the whole life and universal life families. Term life policies do not allow you to benefit from dividends, hence they don’t offer paid-up additions.
What Determines Cash Value Growth?
Every policy must be approved by the Department of Finance. The approved policy schedule is the guaranteed part of a life policy. That’s the money that will be there for you regardless. If the company generates good yields, it then shares them with shareholders (policyholders). As important as profits are for policy value’s growth, ultimately you, the owner, determine your policy’s cash value growth. This growth depends on your decision about what to do with dividends.
Dividends and Your Options
Every year you get a statement on the performance of your policy and its cash value. When you first setup your policy, you have several choices regarding the management of policy dividends. You can use dividends to lower your premiums, receive a check, or reinvest your money into the policy. The reinvestment is what’s called paid-up additions. Reason is that this method raises the cash value and death benefit. You collect interest on interest and these sums, little by little, truly add up. There are several other options for using your dividends, but we’ll get to those elsewhere.
Impact of Paid-Up Additions on Policy Performance
Let’s take a look at a sample illustration of a $100K whole life policy paid for 20 years. The starting point is 30 years of age. The policy holder pays an annual premium of $1629. After five years, the difference is a few hundred dollars. After ten years, this difference becomes a few thousand dollars. At policy maturation, the dividends, according to current performance assumptions, would increase the cash value of the policy by $10,000! And the death benefit by more than $30,000. That’s the power of collecting interest on interest!
If you are 30 and you pay 20 x $1629, then you’ve paid $32,580 into your investment (policy). At the age of 50, your death benefit can be either $100,000 or $134,871. The difference is paid up additions. Collecting interest on interest. At this point, you paid up your policy and you no longer pay premiums. Your money is available to you in a number of ways.
Moving Forward Towards Retirement Age with Paid-Up Additions
But wait, you just created a fund, which is not going anywhere and costs you nothing. The insurance company keeps investing your money and your policy is in force. And since you opted for paid-up additions and did not take any money out at maturation, the money keeps growing. By the retirement age of 70, the difference becomes truly tremendous. The cash value, if you’re keeping dividends every year, is $58,700. With paid up additions your cash value virtually doubles, $115,119. WOW! And there’s more, because the same thing happens to your death benefit. After all that’s what life insurance is about. While the death benefit in Table 1 is $101,327, paid-up additions helped you double that. It is now $200,650.
You signed up for a $100K life policy and ended up with a $200K policy. That’s the tremendous power of paid-up additions!