Premium Offset vs. Reduced Paid-up Insurance
Today, I am going to discuss the difference between premium vacation and a policy change for reduced paid-up life insurance on a participating whole life policy. One of the appeals of participating insurance is that you’re covered for life, but premiums are paid for a limited time, rather than for life. Maximizing the early funding design of participating insurance optimizes the tax advantages of insurance and can create a guaranteed lifelong asset that is funded during a person or business’ best earning years.
At Unity, we frequently use two different tools to shut down premium payments in cash: premium vacations and reduced paid-up policy change (RPU). There are different advantages to each.
Premium vacation, or premium offset, is flexible way to eliminate future premium costs (in cash). Once enough cash value is built-up in a policy, the annual insurance costs, taxes, and expenses are paid from within the policy’s cash value. For the policy owner, the insurance stays in force, and the death benefit and cash value may even grow over time with no new annual out-of-pocket cost. Premium vacations are funded with cash value, which partially depends on future dividend rates. Participating insurance dividend rates have a long track record of stability but are only partially contractually guaranteed. So, it is not guaranteed when (or if) a policy on premium vacation will have enough value to start premium offset (or for how long a policy will support premium offset). The planning uncertainty rests with the policyholder.
If a policy owner wants to eliminate that timing uncertainty, they can opt for a reduced paid-up policy (RPU). With RPU, the uncertainties are shifted to the insurer, not the policy owner. A reduced paid-up policy has contractual guarantees that premiums will never again be owed in cash. Because of that guarantee, RPUs are useful for precise planning horizons. The downside of RPU is that when triggered in the future, the insurance coverage amount will be reduced by an amount that can not be known with certainty today. That said, the insurance coverage amount will usually stay at or above the initial guaranteed face value of the contract. With an RPU, the policy owner may sacrifice a certain amount of coverage for the certainty of a cash premium end date, when compared to premium vacation.
Premium vacation and RPU scenarios vary by insurer and by life insured, which is why it is important to consult a Unity advisor when weighing your options.