Last week, we got a call from a client who got an unexpected $25,000 tax bill. Coincidentally, at this came at the same time as his premium bill, loan interest bill and loan principal bill. He called us and he said, “Guys, do I really need to pay all of this stuff for the policy?”
If you are in a similar position where you have limited cash flow and are wondering what order and priority you have to pay first, stick around to the end of this blog post because we are going over all of the details.
When you get a premium bill and your cash flow is limited, keep in mind that you should always pay the base premium first. When our client called, we showed him that his premium was about a little over $20,000 per year but his policy was over 16 years old. So his cash value increase was going to be over $32,000 from this 16th year to the 17th year. Once he did the math, he realized that he should definitely pay the base premium because for every dollar he put in the premium, he will get a cash value increase of $1.50.
So it makes sense to pay the base premium. And that’s the number one priority, pay the base premium. Especially as your policy matures. It will may seem to be more challenging to realize, but the more you pay into the policy at that time, the higher rate of return you’re going to get within your policy. So always pay the base policy first.
After you pay the base premium, the next thing you should look at paying is the paid up additions rider, if your policy has one. Especially in the first five years. By paying the paid up additions rider in the first five years, it will give you access to more cash sooner so that you can start using your policy to pay for the things of life. The reason why you want to pay the paid up additions in those first five years is because it takes a little bit of time for the policy to mature on its own. After those first five years are up, you may consider closing out the rider or opening the window so you could put money in at a later date.
The third priority to pay is the policy loan interest. The reason why this is third is because, if you don’t pay the loan interest, the loan interest balance will be added to the loan balance and it will may constrict the amount of cash value that is available in the future to access via the policy loan provision.
The fourth area to be paid should be the actual loan balance. By paying the loan balance and as your loan balance gets paid down, your cash equity increases. That puts you in a position where you will have more access to more money later on to accomplish your goals. With the loan balance, every dollar you put in is accessible via the loan provision. A lot of times, this is tricky for our clients to wrap their heads around with this idea because we are trained that debt is bad. But that’s not necessarily the case with policy debt. We are not taking money from the policy. We are putting a lien against the policy. So your cash value will continue to grow and earn dividends as if there is no loan against it. But by paying it down, if you have the cash flow to do so, you will have more access to cash as you pay back your loan. Also, there is less loan interest built for your next policy loan anniversary.
So let’s summarize the order of priority for paying policies. First base policy premium, second paid up additions rider, third loan interest, and fourth loan principle.
If you have more questions or would like to talk to us, feel free to schedule your free strategy session today! – and remember it’s not how much money you make, It’s how much money you keep that really matters.