Whole life insurance policies come with many advantages, but what happens if you can’t afford the premium payments anymore?
Is your entire policy doomed to disappear along with the death benefit?
Luckily, no. And one of the paths you can take in case this happens is to go for the reduced paid up insurance option.
In this article, we’ll cover everything you need to know about reduced paid-up insurance, how it works, and what your other options are.
What Is Reduced Paid-Up Life Insurance?
Reduced paid-up insurance is a common and useful non-forfeiture option where you get full or partial benefits from your original policy. However, it’s only an option for whole life policies.
It’s an agreement between the life insurance companies and the insured when the insured wants to stop paying premiums but still wants some form of life insurance payout.
When you surrender your life insurance policy, you can take out the accrued cash value, but your beneficiaries won’t get the life insurance coverage, the death benefit. If that’s not what you want, reduced paid-up insurance is there for you.
You’ll get a cut down death benefit equal to a level where, based on your premium payments to date, your policy would have been paid up, creating a “reduced paid-up whole life policy.
Most life insurance companies offer a whole life policy with a reduced paid-up (RPU) non-forfeiture option, but your policy will likely have to be a couple of years old if you want to use it.
How Does Reduced Paid Up Insurance Work?
Reduced paid-up insurance lets you stop paying your policy’s life insurance premiums.
You use the guaranteed cash value you’ve built up as a one-time premium payment for a whole life policy, but the death benefit of the reduced paid-up insurance is smaller.
In exchange for no longer having to pay premiums, your life insurance company will give you a reduced death benefit. This lower amount is based on how much cash value your policy has built up by the time you stop making payments.
Also, the cash value of your new reduced paid-up insurance policy will continue to grow due to interest. You can take out a loan from this new accumulated cash value, but you’ll have different rules for paying it back.
Let’s go over the term again together.
Reduced Paid-up Nonforfeiture Option
“Reduced – when you choose an RPU option, you are reducing the policy’s death benefit in exchange for no more premium payments.
“Paid-Up” – The policy is now effectively paid-in-full by using your cash value; with it, you make a “lump-sum premium payment”; this is sufficient to keep your policy in place for the rest of your life.
“Non-Forfeiture” – The policy cannot be forfeited and can’t lapse in the future because all premium payments have been made in advance.
“Option”: RPU is an option because it’s something you can do but don’t have to do. There are some eligibility criteria, but when you meet them, you have a contractual right to choose the RPU option.
Other non-forfeiture options
Let’s say you took out a whole life insurance policy for $100,000. After 20 years of paying for the policy, you decide you’d like to stop paying for it.
In this situation, you can use the reduced paid-up option. But, you can also take two other paths.
The Cash Surrender Nonforfeiture Option
You basically “give up” the permanent life insurance policy and receive the accumulated cash value from those 20 years. Here’s how the cash value surrender option works:
If you have whole life insurance and don’t want to pay premiums anymore, you can either give up the policy and get the cash value or use the cash value to pay for your reduced paid-up insurance coverage.
Cash-value surrender is the most basic nonforfeiture option available. In this case, you forfeit your life insurance for the cash value that has built up in the policy.
Before you get the cash value payment, your insurer will take out any policy loans or premiums you still owe.
When you “surrender” a whole life insurance policy, you choose to give up the guaranteed death benefit and instead get the cash value from the insurance company in the form of a lump sum check or regular payments.
For this reason, a policy’s cash value can also sometimes be referred to as its “surrender value.”
Surrendering a whole life policy for cash makes sense in some situations, but cashing out is certainly not the only possible option for taking advantage of your cash value.
Ideas like “infinite banking” show how your whole life policy can be used in many different ways. It can be used to finance your lifestyle in a way that a bank could, but with zero fees.
What’s important to take in here is that your policy’s cash value isn’t just a theoretical sum the insurance company is willing to pay you. It is a real financial asset that grows in a separate account and earns you interest with each premium payment.
Also, know that when you give up a policy, your original life insurance goes away. You receive the cash value (minus any fees that you owe), but your heirs receive no death benefit coverage.
Because of this, cash value surrender is often seen as a last resort, and you should only do it if you already have other life insurance or no longer need this policy.
Extended-Term Insurance Nonforfeiture Option
A non forfeiture option for extended term insurance lets you purchase term life insurance with the same death benefit as your original whole life policy.
So in this case of extended term insurance, your new term life insurance policy will have a death benefit equal to the previous one ($100,000).
The extended term insurance is purchased with the cash value you have built in your old life insurance plan. The length of the new extended term coverage would be equal to the number of years for which you had premiums paid.
If you had premiums paid for 20 years on your previous policy, your new policy offers 20-year term life insurance, with no future premiums.
However, if you wish to keep your permanent life insurance and still avoid any further premiums, there’s a way to do that, too. And it’s reduced paid-up.
With all three of these options, you no longer have to pay premiums. Your policy might even include a reduced paid-up illustration to clarify exactly how much you would receive.
Reduced Paid Up VS Paid Up Additions Rider
Reduced paid-up insurance is NOT a paid up addition (PUA)—though the terms have a similar ring to them.
People often say that paid-up additions are small life insurance policies that go along with a larger whole life policy.
You purchase paid-up additions in full with dividends with no future premium payments, which is why they are called “paid-up additions.” Once a paid-up addition is purchased, its death benefit is guaranteed for life.
Policy riders give you the right to buy paid-up additions, but they usually start with a higher premium.
As we’ve already said, the reduced paid-up nonforfeiture option is one of the ways that people with whole life insurance can change their policies to fit their changing lives, markets, and finances.
How Reduced Paid-Up Affects Paid-Up Additions
If you want to go for the reduced paid-up policy, you’ll lose most of your life insurance coverage and likely have to say goodbye to all the riders in your original life insurance policy.
In many cases, paid-up additions can still be purchased after you choose an RPU, given that the rider was included with the fully paid up policy and survives your RPU election.
Also, because of the decreased death benefit after an RPU election, the dividend amount (and the death benefit of the paid-up addition) usually goes down, at least for a while.
Pros and Cons Of Reduced Paid Up Insurance
For the sake of an example, let’s assume you have a policy with a $100,000 guaranteed death benefit, an accrued cash value of $35,000, and that you have thus far paid aggregate premiums of $25,000.
You’re getting ready to retire, your kids are self-sufficient, and you no longer need $100,000 in life insurance coverage.
If you surrender the policy, the $10,000 in growth will be deemed taxable income.
However, if you elect reduced paid-up life insurance, the policy will convert to a death benefit of around $35,000, payable to your beneficiary upon your death, completely tax-free.
After this, your policy’s cash value will keep growing thanks to guaranteed interest and possible dividend payments, and you will never have to pay another premium.
Plus, you can always take out a loan or surrender the policy for the cash value if you desire.
The obvious downside of an RPU is that it lowers the death benefit of the policy. The size of this reduction depends on a number of factors.
However, if you think your other assets will be sufficient to take care of your loved ones, choosing an RPU to halt premium payments and free up funds in your budget can be a good financial move.
Of course, there are other major things that need to be considered here.
RPU Affects Riders
The coverage provided after an RPU election is usually more stripped-down than it is in your policy, and many life insurance riders may not survive this transition.
If you’re counting on a rider that, for example, triggers coverage in the event of a terminal illness or severe injury, an RPU election might not be a good idea.
An RPU Is Irreversible
Reduced paid-up is generally irreversible.
Some states and policies let you get your policy back within a certain amount of time, but you usually have to pay back any further premium payments you missed in the meantime.
However, in most cases, once a policy is converted to RPU, there’s no going back.
You are not only free of the obligation to pay future premiums, but you also have no choice but to pay further premiums.
This means that, when you stop paying premiums, you won’t be able to use the whole-life policy’s guaranteed growth as a hedge against poor performance by other investments.
|No further premiums||Smaller death benefit|
|Death benefit forever||You’ll lose riders|
|You can take out a loan |
from the cash value
Who Is Reduced Paid-Up Insurance For?
An RPU option can be beneficial for individuals who want or need some life policies and death benefit coverage but whose financial situation has changed (i.e., retirement income) in such a way that it no longer makes sense to pay premiums.
The reduced paid-up coverage is also helpful for people who want to keep a death benefit but can’t pay the monthly premiums anymore. This prevents the policy from expiring.
If you want to avoid paying income tax when cashing out a policy, you may also want to choose an RPU.
A life insurance payout is not considered taxable income, and policy proceeds can be kept out of an estate that is taxable in a fairly simple way. If you choose an RPU, you’ll pay less in taxes, your policy won’t lapse, and you won’t have to pay any future premiums.
Before making an RPU election, it’s best to discuss the effects of this choice with an experienced life insurance advisor.
Think carefully about the pros and cons of this option before choosing it to avoid paying taxes you don’t want to pay or losing policy benefits.
Who Shouldn’t Choose Reduced Paid-Up Insurance?
Reducing your paid-up insurance policy may not be the best option if you currently make use of policy riders. In most cases, all riders are eliminated when you use the RPU.
Be prepared to lose it, whether it’s a paid-up additions rider, a guaranteed insurability rider, or something else.
How To Own Your Own Lifestyle
Sometimes people get into financial hardship and have to use the reduced paid-up option, or even surrender their policy completely.
But if you learn how to use your policy the right way, it could even become self-sufficient and help you reach your other financial goals.
Say hello to Lifestyle Ownership.
Purchasing a whole life insurance policy is the first step toward financial independence.
The plan gives you two options once you reach a sizable cash value. You can let this money grow at a set interest rate, or you can borrow against your life insurance policies and use that to cover expenses.
The catch is that you are effectively borrowing money from yourself rather than from a traditional lending institution.
In other words, you get to call the shots, reimburse yourself with interest, and sidestep the standard charges.