Up Life Insurance Policy Option?" width="100%" height="145px" />Rebecca Lake is a certified educator in personal finance (CEPF) and a banking expert. She's been writing about personal finance since 2014, and her work has appeared in numerous publications online. Beyond banking, her expertise covers credit and deb.
Rebecca Lake Banking ExpertRebecca Lake is a certified educator in personal finance (CEPF) and a banking expert. She's been writing about personal finance since 2014, and her work has appeared in numerous publications online. Beyond banking, her expertise covers credit and deb.
Written By Rebecca Lake Banking ExpertRebecca Lake is a certified educator in personal finance (CEPF) and a banking expert. She's been writing about personal finance since 2014, and her work has appeared in numerous publications online. Beyond banking, her expertise covers credit and deb.
Rebecca Lake Banking ExpertRebecca Lake is a certified educator in personal finance (CEPF) and a banking expert. She's been writing about personal finance since 2014, and her work has appeared in numerous publications online. Beyond banking, her expertise covers credit and deb.
Banking Expert Ashlee Valentine Deputy Editor, InsuranceAshlee is an insurance editor, journalist and business professional with an MBA and more than 17 years of hands-on experience in both business and personal finance. She is passionate about empowering others to protect life's most important assets. Wh.
Ashlee Valentine Deputy Editor, InsuranceAshlee is an insurance editor, journalist and business professional with an MBA and more than 17 years of hands-on experience in both business and personal finance. She is passionate about empowering others to protect life's most important assets. Wh.
Ashlee Valentine Deputy Editor, InsuranceAshlee is an insurance editor, journalist and business professional with an MBA and more than 17 years of hands-on experience in both business and personal finance. She is passionate about empowering others to protect life's most important assets. Wh.
Ashlee Valentine Deputy Editor, InsuranceAshlee is an insurance editor, journalist and business professional with an MBA and more than 17 years of hands-on experience in both business and personal finance. She is passionate about empowering others to protect life's most important assets. Wh.
| Deputy Editor, Insurance
Updated: Nov 15, 2022, 7:00am
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Up Life Insurance Policy Option?" width="100%" height="145px" />
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Life insurance is an important financial planning tool if you’re concerned about your loved ones being left in a tight spot if something happens to you. But what if you can no longer afford to pay the premiums to keep your coverage in place?
Reduced paid-up life insurance may be an option. Eliminating life insurance premiums could save you money in the short term. But it’s important to consider the longer-term implications before deciding if this is the right option for you.
Reduced paid-up insurance is an option with some life insurance policies that allows you to retain a death benefit from your life insurance policy without paying anything toward premiums. A reduced paid-up option might be built into your policy if you have whole life insurance.
When you buy whole life insurance, part of the money you pay in premiums is allocated to a cash value account. The money in that account can earn interest. If you find that the premiums for your whole life policy become unaffordable, you could surrender the policy and withdraw your cash value.
The trade-off is that doing so eliminates the death benefit. So if you pass away, your beneficiaries would no longer receive any money from the insurance company.
Reduced paid-up insurance offers a workaround. Rather than surrendering your policy, you can use the cash value to convert to a paid-up policy with a smaller death benefit. You wouldn’t have any additional premium payments to make, since the policy is effectively “paid up” using your cash value.
A reduced paid-up provision is only an option with some permanent life insurance policies. If you have term life insurance, there’d be no cash value to apply to the premiums. Term life insurance is typically less expensive, however, so it’s less likely you would need to surrender a term life policy.
Reduced paid-up life insurance works by offering an alternative to surrendering your policy. If you were to surrender a whole life policy, you’d be able to withdraw its cash value minus any surrender fees. You could use that money as you see fit, and there would be no other premiums to pay because the policy would end. But the death benefit for your life insurance beneficiaries would also be gone.
When you use the reduced paid-up provision in your policy, the insurance company adjusts the death benefit to cover the accumulated cash value. Insurers base their cash value calculations on the following:
So, for example, if you’ve built up $50,000 in cash value on a $500,000 policy, your new death benefit amount would be about $50,000. The policy would then remain in place for the remainder of your life, with no further premium payments due.
You can typically continue accumulating cash value with a paid-up policy or earning dividends if your insurance company pays them. And switching to a reduced paid-up insurance option wouldn’t bar you from later withdrawing or borrowing against the policy’s cash value. Keep in mind, however, that any withdrawals or unpaid loans remaining when you pass away would further reduce the policy’s death benefit.
The main benefit of reduced paid-up life insurance is the ability to eliminate premium payments. That might be appealing if you’re interested in curbing your expenses but still want to retain life insurance coverage.
You could then use the money that would ordinarily go toward life insurance premiums for other financial goals. For example, you might prefer to invest the money to build wealth. Or you may simply need it to cover day-to-day expenses if you’re experiencing financial hardship.
At the same time, you and your beneficiaries have the reassurance that there will be a death benefit remaining once you pass away. While the life insurance payout will be reduced, the smaller death benefit can still provide your loved ones with money to pay for final expenses or other costs.
Choosing a reduced paid-up option in lieu of surrendering the policy to withdraw cash value can also benefit you from a tax perspective. Cash value withdrawals that are equivalent to the amount of premiums paid are not taxable. However, gains or dividends that exceed your basis in the policy could be taxable.
Aside from tax savings, reduced paid-up life insurance can help you to avoid surrender charges and fees. Insurance companies charge these fees to offset the loss of future premium payments. Whether you’ll pay a surrender fee when cashing in a life insurance policy can depend on your policy terms and how long it’s been in place.
While there are some situations where reduced paid-up life insurance could make sense, it’s important to consider what you might be giving up by exercising this option.
Although you remain covered by a life insurance policy, the death benefit amount paid out to your beneficiaries is much less. That may not matter if you have a large estate to pass on, since your heirs could draw on other assets to cover necessary expenses.
If you’re leaving behind significant debt or are an income earner in your family, however, your beneficiaries’ finances may be negatively impacted by a reduced death benefit.
Converting your whole life policy to reduced paid-up insurance would also strip it of any life insurance riders you’ve added. And if you paid extra fees to include riders, you will not be able to get that money refunded.
Reduced paid-up life insurance is best for people who want to cut premium payments out of their budgets while retaining some life insurance coverage. Opting for reduced paid-up insurance could make sense if you’re:
It’s important to ask your insurer if you’re eligible to convert your policy to reduced paid-up insurance. Not all policies have this option. Reduced paid-up insurance may also not be an option if you have not yet built up enough cash value in your policy.
In that case, you may need to weigh the value of surrendering the policy instead. You could use the cash value you withdraw to purchase a smaller, less expensive policy to reduce your premium costs. Shopping around can help you to find the best life insurance option for your needs.
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