Understanding Paid Up Additions for 2020 – Episode 371

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[00:02] Kim, I’ve heard that the alpaca family is growing. We want the news. Yeah, yeah. We have five new alpacas that are wakaya and that means they’re the pencil-y, dreadlock-y kind and they are too brown, too white and kind of a tan colored one that we were given. So special from a new friend, not somebody that we knew in Colorado, who she had been given them from a friend that was getting a divorce and said, I can’t deal with these, please take them. She had farmland so she took them but she didn’t really want them and so we paid for an alpaca shipping company. Did you know those existed? I didn’t and I could say that may be the most obscure business I’ve ever heard of. This crowd came from Oregon, drove across the country, picked up, dropped off, picked

[00:58] up, dropped off, grabbed our alpacas in Denver, Colorado, drove them down to Mount Enterprise, Texas, dropped them off, had others in the trailer and kept on going to the East Coast where he was continuing to pick them up and dropped them off along the way. That is some story. Wow. And just when I didn’t think I could hear of anything more strange in 2020, I just did. So speaking of that- Cleanliness included, of course. Yes, of course. I’ve referenced 2020 because that’s the topic of this conversation, which is about paid up additions. So PUA is what they often call it and if you’re looking at the show notes of the podcast, now you’ll know what PUA means. And we’re going to talk about the paid up addition contributions in 2020 with life

[01:49] insurance and I think it’s going to be insightful for the listeners. Yes. This is such a misunderstood area and so I’ll do the best to break it down. And let’s clarify in case somebody doesn’t know that paid up additions are extra money that you can add on top of premium to build more cash value faster. And it’s also really important that everybody remember that premium builds cash value also. You know, when we hear the word premium, we want to think car and home insurance, which in our minds, premium equals cost. But that’s not accurate with whole life insurance. Premium does, of course, help pay for the costs and it builds cash value. Paid up additions tend to build cash value at about 95 percent, meaning if you

[02:39] put in, say, $10,000, $9,500 would go to literally straight to cash value. And that additional 500 usually raises the death benefit a little bit. So hold on there. I know some people think, oh, I don’t want my death benefit to raise. Well, if it doesn’t, then you are at risk creating what’s known as a modified endowment contract. So lest you fall asleep for this discussion, I’ll go quickly. A modified endowment contract, MEC, it’s called, is where the IRS says, hold on there, buddy, you’ve got too much cash for the death benefit. Well, if the death benefit rises, then that solves that problem. Are we good so far? We are. You know, you answered the question that I had written down. So you’re one step ahead.

[03:24] Awesome. So what limits are paid up addition? Well, it’s the modified endowment contract limits. And there are two tests that are used by the life insurance companies to identify this. Now, the MEC law was created by the IRS, but the life insurance companies interpret it. And so there are slight, very small, but there are slight differences between the various companies. And as we’ve shared so many times on the podcast, if you’re with a whole life mutual company, it’s fine. Please stay there. Add if you want, but please, please don’t be thinking, oh, my gosh, I could go over here and get a better X, Y or Z. No, no, no, no, not with whole life, not with these companies that are all 100, 150, 180 years old.

[04:12] There is no better mousetrap. However, this modified endowment contract interpretation does have two parts. And the first is what’s called a seven pay test. And I won’t get into the proper terminology, but it obviously tests for your MEC limits every seven years, which is why if you’ve ever looked at an illustration that is trying to kind of tap out and hit that top level, you’ll see a change in the eighth year and in either 14th or 15th year and essentially every seven years along the way because of that seven pay test. Well, guess what? There’s also a one pay test. And so literally every single year, a test is performed by the life insurance company’s actuarials. So this is not like an Excel spreadsheet mathematical calculation.

[05:04] It’s an actuarial calculation, meaning it takes into the consideration not only all the normal math that we would consider, but also your age and your gender and things that impact your lifespan. So that makes it actuarial actuarial science. There is a fun topic for discussion. You think accountants and mathematicians are bad. The limits for 2020. And I should first state that your policy does not operate on a calendar year. Your policy operates on a fiscal year. So if you have, as an example, a March 15th policy date, then your policy goes from March 15th of, say, 2020 to March 14th of 2021. And that is your year. It’s a fiscal year. It’s not a calendar year. It means something other than calendar.

[06:01] Think about corporations that operate on fiscal years. And so you will absolutely want to know your own policy’s anniversary date, because it is on that date that your next year occurs. And there is a little bit of leeway, usually. There’s usually about a 30-day play in either direction. And again, it depends a little bit on the insurance company and their rules. But you can sometimes affect your fiscal year, the previous year or the post year, depending on that 30-day window on either side of your anniversary date. And the best thing to do is to ask your life insurance company or your agent every single year for what your maximum paid up addition is for that year. And that way, you won’t mess it up.

[06:56] Because the number does move around a little bit. Now, at the beginning, you were probably told a certain number. And that’s a legitimate guideline. But especially if you’re really trying to top this off and put in as much paid up addition as you possibly can, you need to be aware that there is actually calculation done every year. And there is an actual number. And sometimes, I even recommend people shave a couple hundred bucks off the maximum just so that they don’t trigger a modified endowment contract. Because if they do, then the insurance company has to send the money back. And it just gets kind of messy from a bookkeeping standpoint. But then when you look at your maximum paid up addition,

[07:41] so when I use for 2020, it’s just the generic year. It could have been a little on the beginning or a little on the end for you. There is some other things that impact it. And one of them is the very low economic interest rates that we’re having. Again, this is nothing to do with the stock market, but just our economy’s interest rates are so low that that actually impacts the life insurance company’s MEC calculations. And as you’re also well aware, it impacts the dividends also. So that might actually put a limit on your paid up addition a little bit. You may or may not notice it, but it can limit it some. Additionally, just the fact that the life insurance companies are also struggling for where do they store their cash.

[08:34] My husband, Todd Langford of Truth Concepts likes to say that they’re stacking it up on the shelves because they don’t know what to do with cash right now either, which means that they don’t necessarily want a whole bunch of paid up addition money. Now, of course, they’re not going to turn it away. They will accept it and they will put it to work the best that they can. And it goes to cash value and it will earn the dividend that gets paid this year, assuming a dividend gets paid, which we know that most good life insurance companies have paid dividends for well over a hundred years, some of them a lot longer than that. So we can be reasonably confident that our paid up addition money is going to also earn a dividend.

[09:15] Nevertheless, it does go into cash value and even if a dividend does not get paid, there is still a guaranteed increase in that cash value. We talk all the time about how the cash value is guaranteed, but I think we forget, and I’m guilty of this too, to separate out the second half of that guarantee, like the cash value is guaranteed, but it’s also guaranteed to grow, even if there’s no dividend. Were you clear on that distinction, Spencer? I’m curious. No, I wasn’t, I just took note, cash value and the growth is guaranteed. Yes, absolutely. And so what happens is every time you add a paid up addition dollar or any time a dividend gets paid, that obviously increases your cash value and then that sets a new floor

[10:06] of which that cash value will never go down from, and from that floor, it is guaranteed to grow. It might be boring as I’ll get out, but it will not be taxed and it will grow. And so those are important distinctions and I hope we don’t ever have to do a podcast where we’re talking about a year in which life insurance companies didn’t pay dividends, but it could happen. And if it does, it’s nice to know that our cash value is guaranteed to grow anyway. Absolutely. So I think there’s two points that I wrote down that are really kind of triggering some thoughts. One, what Todd mentioned, life insurance companies now are, we’ll call it stacking the cash, and it makes us realize this. If they have been a solid institution for this many years

[10:57] and have continued to see growth and pay these dividends and they’re following that principle, that should be maybe a little bit of an inkling and insight that that’s what we should be doing as well as people. Two, you mentioned something that the pay to petition changes every year, which should trigger a conversation with the agent. So what else should clients or even listeners be asking their agent so that they can get the most out of every single year of having their life insurance policy? Oh, that’s a great question. And holy cow, I’ll admit that I don’t get to talk to every one of my clients every single year. It’s simply impossible to do after being in business for 30 years. It’s part of why I do the podcast

[11:40] to enable a conversation where it’s not literally a particular schedule on my calendar. And so thankfully most insurance companies these days have the ability for you to get this maximum pay to petition number online so that you can just pop in, look it up, add your money. Now, some of you may be adding money monthly and you already have your maximum pay to petition included in your monthly contribution. It might still be worth checking because there might be a little bit of extra room and you might be able to put in a lump sum of 500 or 1,000 or it’s very relative to your size of policy. So maybe it’s 10,000. On top of the monthly contribution that you may have already been doing. And then like I said, there are some years

[12:29] that seventh and eighth year timeframe, the 14th, 15th year timeframe, where it just almost inexplicably bumps up. And so you would wanna be aware of that and put in the extra money if you had it. I think another good question to be asking yourself, whether you ask it of your agent or not, is always just a beneficiary check-in. I’m always so saddened when I hear that somebody got divorced and it’s usually 401k plans that are the problem, not life insurance policies, but the ex-spouse was never taken off the 401k plan and now the person has died. And there’s maybe another spouse or children that were anticipating getting that 401k plan, but the beneficiary is the ex, not a good thing. So that’s something that you can, again,

[13:16] very easily check online and is worth a look-see every single year. And then we all also want to remember that buying second and third and 10th and 15th and 20th life insurance policies should become the norm for your family. So you start out with one or two, get a third and fourth, maybe on a child. Maybe if you’re a grandparent, you’re also buying them on grandchildren. Maybe you’re gonna hit round six and seven and eight, and depending on how many kids there are, and back to the main breadwinners. Maybe there’s a business relationship that you have a insurable interest in, so you’re buying another policy down the road. I mean, this does not happen overnight, but people that seriously consider

[14:07] the cash value of their life insurance as their financial foundation, in the nth degree of that word. Think about what a foundation does for a home. Think about the fact that if you wanna build a big home, you need a big foundation. Think about the strength. I mean, all of those things, it’s such a perfect analogy. If you consider cash value of life insurance, your family’s financial foundation, you want to build that portfolio of policies up as much as possible. And this is not talked about. Everybody likes to brag about their portfolio of real estate and their portfolio of stocks, and et cetera, et cetera. Art, you name it, collectibles, but nobody even brags about their portfolio of life insurance policies.

[14:51] Well, I will. I have over 20 at times in my life. I’ve had over 30 when I had a bunch of term insurance because I had young families and young businesses that would crater if I was not around anymore. And so this should be normal for a lot of our families. They should be up over time into the double digits of numbers of policies to own because exactly what we’ve been talking about, your pay to petition capacity is limited by the size of the policy when it was first purchased. And so if you want more capability, you’ll buy a second, third, 10th policy that will then give you, of course, more pay to petition and more premium and more death benefit. And that will all just continue to build and grow.

[15:41] No, it’s so well put together. I think for listeners, there’s always that first step off the ledge once you commit and do it. And then it all starts to make sense. It’s as though the puzzle pieces are shattered and you take that first step and then the corners get put together and then you add in more and more policies and you see how it benefits your life. And the conversation that you just did today about understanding the pay to petitions, I think will help our listeners to realize that this is a long-term play for your family, for your future, for your finances. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com.

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