Secrets of (PUA) Paid Up Additions – Episode 408

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[00:00] I founded Ornot in 2013, and we made clothes for cyclists. For me, the best part of Shopify is the possibility of managing the business even without technical knowledge. We managed to manage everything, from back-end to front-end, and make sales online, without complications. If Shopify were a cycling equipment, I would say it would be the bicycle itself. And that’s what allows us to get where we want. It is in Shopify that we manage our business. Start your free evaluation at Shopify.com We’re going to be talking about the secrets of paid-up additions. Now, if you’re not familiar with that term, we’re going to unpack it, and we’re going to share this little known secret. Or I should say, smart groups of people understand this, and we want to share it with you.

[00:48] How about that, Kim? It works. Paid-up additions are so fun, and what an odd thing to say is fun, which is a tiny rider on whole life insurance policies that exist to enable you to build more cash value. So let’s try that again. Yeah. Yeah. But if I recall, there’s a couple of things in this that you have to do right, because if you put too much in, then it can go against you. You don’t do enough, and you don’t get the rewards. So you got to walk that tightrope just right. Correct. And that is a little easier to do than people make it sound. So let’s first be clear that paid-up additions, again, a rider that goes on to a whole life insurance policy. It’s not available on term life insurance.

[01:45] It’s not available on universal life insurance. It’s not available on variable or index universal life insurance. It’s only available on whole life insurance, and it’s not even necessary to have the rider in order to get paid-up additions, but most people want the rider to add more paid-up additions. Please allow me to explain. So you have with a whole life policy something called a dividend that operates very differently than stock dividends, but nevertheless, it is a dividend from the life insurance company, and typically in the second year, sometimes policies pay them in the first year, but typically in the second or even could be the third year, your dividend is going to start, and most whole life insurance policies dividend elections are for paid-up additions.

[02:40] So what exactly is a paid-up addition? So you’re either having your dividend by paid-up additions, which I like to think of as automatic paid-up additions, and if you’re wanting to learn a little bit more about this space, we have a great little book. It’s called Live Your Life Insurance. It’s available on Kindle, on Softcover, and on audiobook, and it explains and even has a glossary in the back about some of the funny terms like paid-up additions that life insurance, specifically whole life insurance uses. So you can have, and it talks about this, an automatic paid-up addition, which is where the dividend election purchases paid-up additions, or you can have a manual paid-up addition, and Spencer, this is what you were talking about,

[03:25] and manual paid-up additions, meaning you’re going to put in extra money specifically for paid-up additions, typically have a minimum and a maximum. So what this paid-up addition is, is a paid-up, hence the word, meaning no more premiums are necessary, no more additions, no more contributions. So it’s a paid-up additional policy, and so your base policy, let’s say you buy a million-dollar whole life insurance policy, or $100,000, zeros are not really relevant, and that’s the death benefit of the policy, and then your paid-up addition is actually going to be about another 10% of death benefit, really rough numbers, if you just kind of minimalize it, and it could be as much as 20% or even 200%

[04:20] if you do some special term writers along with it, of the death benefit. So it’s an additional policy, and it gets attached to the base policy. So we have a paid-up additional policy that does all of the things that the base policy does, except require premiums because it’s paid up. So it also creates dividends. It also, this paid-up additional policy, builds cash value. It also has death benefit. So are we clear so far on what a paid-up addition is? Yeah, I think we’ve got the foundation. The foggy part is understanding the details, and then how one squeezes the most out of it. Yes, absolutely. We want that optimal efficiency, and optimal means as big as possible with efficiency in place. In other words, not just big for the sake of big,

[05:17] but big so that our monies are working harder for us. So as I mentioned, there is a minimum and a maximum, and the paid-up addition minimum is usually set by the insurance company, and it’s literally $100 to $250. I see them in that landscape, and that’s per year, very small minimum paid-up addition rider. And it’s not a fee for the rider. It’s an actual deposit or contribution to the paid-up addition. Then the maximum is a bigger number. I’m trying to think of a sort of common rule of thumb that I could say, but I can’t, and here’s why. And that’s because it is very much a function of your base policy, your age, and your gender. And there’s a lot of marketing companies on the web that are, for example, talking about a 90-10 plan or a 70-30 plan

[06:18] where 70% to 90% of your total contribution goes to paid-up additions and 10% to 30% goes to your base premium. It doesn’t really work that way. The way that it works is you tell a life insurance company’s computer, and this has to be done through an agent. This is one space where I don’t care how online and webable you are, and I consider myself very online and webable. You still have to go through a life insurance agent to get access to this information. And that is the agent’s contact into the life insurance company’s computer that does the actuarial calculations, very important actuarial calculations to figure out that maximum paid-up addition. But beyond that, it’s not that hard, and here’s how it works.

[07:12] We put in your state of residence. It’s not really relevant to the numbers, but it’s relevant to the licensing. So we have to have your state of residence. We have to have your date of birth, and we have to have your gender because it is different in most states for females and males. Not a lot different, but some. And then there’s a nice little box that the insurance companies allow us to check, which is maximum paid-up additions. And there’s a subset to that information, which is under the MEC limit. So you want maximum paid-up additions, but under the modified endowment contract limit, MEC, modified endowment contract. So in the 80s, the IRS came through the life insurance industry and said,

[07:58] hmm, there’s people putting way too much money in life insurance. We’re going to limit this ability. We’re going to create a law that says if you put in too much money for your age for the death benefit that you are buying, let me say it again, if you put in too much money for your age and the death benefit you are buying, we are not going to let you work within life insurance tax law. You’re now going to be forced into modified endowment contract tax law, which is not as effective. So most people want to stay underneath the MEC limit, which is the maximum paid-up addition, the maximum amount of money that you can add to your base policy to create cash value and still have it taxed like life insurance, which is the better taxed law,

[08:51] as opposed to modified endowment contract tax law, which is basically like an annuity and not nearly as effective. Now how are we doing? It makes me think of one thing, which is the government oftentimes, depending on a person’s perspective, you can look at this and you can be frustrated at them changing or getting their hands in. But essentially what they’re doing is they’re guiding us and telling us where to go. And now we get to be more efficient. Yes, yes. And as Tom Wheelwright so wisely says, the tax laws are just the government’s guidance for the incentives that they want us to do. And so fine, we can take advantage of that in a good way. And we should. It’s really our American duty to do so.

[09:41] And life insurance is not a tax loophole. It is taxed properly. So think about this just a little bunny rabbit trail here real quick. When you get money because you had a car accident and the insurance company is giving you money for your car, you’re not taxed on that because it’s just replacing something of value that you lost. Life insurance is no different. That death benefit replaces a person’s human life value. And while most people don’t own their entire human life value in whole life insurance, they may have a combination of whole life and term to do that. It’s still a replacement. You can’t really make somebody rich with life insurance because the life insurance companies are not going to allow them to get that much, which actually does.

[10:24] So now back to main trail off bunny rabbit trail. It brings us back to this idea of maximum pay to petition. Some people will say, I heard about that 90 10 thing. I want to do that. Well, if you’re 50 years old, you’re not going to get 90 10. I don’t care how many writers you add to it because there’s just a limit due to age because it is an actuarial calculation. On the other hand, if you’re 10 years old and maybe your parents are trying to buy insurance for you, you’ve got limitations there too, because again, based on the death benefit, the human life value, the appropriateness for a 10 year old, you can’t just go buy a $2 million policy on 10 year old on some 10 year olds. You could if their family was wealthy, but your basic 10 year old, you can’t get,

[11:07] for example, the RTR writers on somebody that’s under either 15 or 18 or it might even be 21. I can’t remember. It depends. I think on the insurance company, these special term writers that you hear people talk about, they’re not available on children nor should they be. So it’s a landscape that just frankly requires a little bit of help, not a lot of help for our type of clientele that they’ve done some self education and some research and some reading. They can call me and with a very quick conversation, we can figure out what it is that they’re looking for. And then we can go to the life insurance company’s computers, pop in that little bit of info that I indicated. Another missing piece would be

[11:49] how much they want to contribute every year. And then the life insurance company’s actuarial calculations are going to tell us all of the other pieces and parts. And while there’s a little bit of manual fudging around that we can do, we can add a little writer here, tweak a few things there. There is not a substantial amount of difference that, quote, the agent can do. And it’s sad to me that it’s talked about out in the marketplace as if the agent has the choice to dial in their commissions. And I guess in a way they do, because I guess they could not tell you about the paid up additions writer, but it’s out in the landscape pretty well. I mean, most people know about it in some form. If they’ve done any kind of life insurance research, especially around the concepts of

[12:38] becoming your own bank or the infinite banking concept or cashflow banking or the various terms that are out there that pretty much all mean the same thing, which is maximum cash value, minimum death benefit. And then this begs the question, I think also very importantly, of what do we do about the additional death benefit that a lot of families want or need? And the answer is term insurance. Term insurance is talked about badly in so many cases, and there’s nothing wrong with it at all. It’s good insurance, it pays if somebody dies, and it’s perfectly acceptable to use. I still own term insurance in my mid-50s because I don’t have enough money to convert all of it to whole life yet. And I may or may not ever

[13:21] have enough money to convert all of it to whole life yet. So term insurance plays a role there. And yet these pay to petition writers, when either minimized or maximized, which can be varied year by year by year, are so efficient and so effective. And we absolutely do want them on our policies. We want them included. Yes, it does as a percentage of the whole, reduce the agent’s commission. And that’s perfectly fine. It works really, really well for all parties, which is what we’re always seeking, right? We want a win-win-win. So in this case, this is a win for the buyer. It’s a win for the seller, which is the agent, because they get a good client that’s going to see cash value right away and understand the

[14:06] policies. And it’s a win for the life insurance company, which we want it to be, because these are mutual companies. They need to be profitable. Otherwise, our money is not safe. And they also are owned by the policyholders, the very people that are paying the premiums and the paid up additions are buying policies as well. And then there’s one more secret that I want to make sure we cover questions, thoughts. You know, with the paid up additions, there’s a couple of questions, because I’ve had this come up in conversation, which is understanding how much that’s going to be, which you’ve covered the making sure you don’t cross the tipping point and turn it into a modified endowment contract. We’ve covered that.

[14:50] And then the last one is at what point will people, you know, if you have your policy set up properly, be able to use it and see the benefit of that? I imagine you’re probably going to be touching on that soon. Yeah. So you can borrow against your cash value as early as the second or third year. I don’t always recommend that because your cash value, which is, and this is the additional point I wanted to make sure that got made. Your cash value is the function of both your premiums and your paid up additions. We get stuck on the word premiums because we think of car insurance and home insurance where premium equals cost. And I’ll have people call sometimes and they’ll say like, I want a dollar of premium and everything else paid

[15:37] up addition. Well, that’s not available. If you actually had a dollar of premium, your paid up addition would be, you know, maybe $2 at the most period, end of discussion. Like it can’t be $20. It is limited again, based on age and death benefit amount purchased. So the premium builds cash value, the paid up additions build cash value, and it’s all in one cash value account, although it is broken down. So you can see the difference. And clearly in the early years, the premium does largely go to pay for the cost of the death benefit. Whereas in the later years, I’m talking like seventh and eighth year, the premium is going all to cash value because all of those other costs have been largely paid. So when it relates to borrowing against said cash value to go solve emergencies or take

[16:29] advantage of opportunities, that’s what your cash value should be to you is your emergency slash opportunity fund. Well, if you’re borrowing against it right away in the second or third year, it better be for an emergency because in my opinion, you want to build that account up so that you have your emergency fund stored in the life insurance company instead of in a bank. Life insurance companies pay those dividends. They’re higher rates of returns. They’re not taxed. And so that’s a better place to store emergency money. Well, if you’re borrowing against it right away for an opportunity, that means you’re not having your emergency money in there. So ideally, I would prefer to see it left alone. But

[17:10] that’s just my preference. And obviously, sometimes we don’t get a control when emergencies happen. So it’s absolutely acceptable to borrow. Some companies really don’t want it until the second year, but most of them don’t really toe the line on that. If you have cash value, you can borrow against it. And then, in my opinion, you want to be paying that back as quickly as possible so that it can do the job it’s supposed to do, which is be there for emergencies. But then, of course, fairly quickly, you’re going to surpass that number, whatever your family’s emergency number is, if it’s 50,000, 100,000, 10 million, whatever your number is, you’re going to surpass that number and then go on and continue to build that cash value account up

[17:56] so that your family can use it for opportunities. That’s where it gets fun. It really does at that point. Yeah. And paid up additions, if you can maximize them or optimize them every single year, are just going to create that opportunity fund that much faster. Yes, absolutely. Dovetail that to the earlier comment about taxes and how the government has dictated how that goes and the conversations we’ve had on this podcast and being able to see people approach opportunities using this in the tax environment is absolutely amazing. This was a good, you unpacked it well, Kim. Always fun to do. Thank you, Spencer. Listeners, thank you for tuning in with us. If you’re not already a subscriber, make sure you

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