Earn 15%+ by Taking Advantage
of Prepayment Discounts
From insurance premiums to tuition payments, many people make monthly or quarterly payments when they could earn a discount for paying in full in advance. Indeed, you might be surprised at the effective rate of return you can earn by paying your entire bill up front rather than electing to pay in installments.
Consider an insurance policy costing $1,000 annually if paid in full up front. Or you have the option of paying $87.50 monthly. How much does it cost to pay it in monthly installments rather than paying in full? In absolute dollars, that's an easy calculation: twelve payments of $87.50 is $1,050. So the insurance company is charging you $50 for the luxury of spreading your payments out.
But suppose you have money in your Level 2 savings that will not be needed over the coming year. The question now becomes, "Should I withdraw enough to pay in full now and save the $50, or should I leave my savings undisturbed to earn interest?" In other words, "What does the $50 translate into as an interest rate, and how does that compare to the rate I'm earning on my savings?"
At first glance, you might think paying monthly is costing you 5%, since $50 divided by $1,000 equals 5%. However, the amount you owe to the insurer declines by $87.50 with each monthly payment. Initially you owe $1,050, but by year-end you owe nothing. So, the average outstanding balance for the year is around $500. That means the $50 additional charge you're incurring is closer to paying an interest rate of 10%.
You can find the exact number by using a financial calculator. Doing so reveals the exact annualized interest cost for this example to be 10.8%! (This is based on withdrawing $912.50 from savings to go with the $87.50 you have on hand, and assumes the 11 monthly payments are made back into your savings account. It's important to be faithful in this regard; if you fail to deposit even one of these payments, you'll more than undo the interest rate advantage you have realized.)
So, in effect, 10.8% is what you'd earn on your money if you pay the $1,000 premium rather than $1,050 going the installment route.
But it gets better! Because the additional $50 the insurance company is charging you for the "convenience" of making monthly payments must be paid with after-tax dollars, not having to spend that $50 is like earning 10.8% tax-free.
Assuming you're in the 25% federal tax bracket, that 10.8% is equivalent to a pre-tax return of 14.4%. That's pretty good, in a low-interest rate environment like we have today. Plus, you save the time of writing a monthly check, and the cost of an envelope and postage.
In a similar vein, when I ran the numbers for a tuition plan at a private elementary school, the effective pre-tax return for paying in advance exceeded 20%!
(For insurance policies, typically you can change to an annual payment even if you're not at the policy anniversary. Ask the company how much is needed to pay to the anniversary. Send this with a request to bill you annually in the future.)
Be careful not to strain at a gnat while swallowing a camel. This is a fine-tuning step that assumes you've already answered more basic questions such as, "Do I even need this product or service?" or "Is there a better buy?" Regarding insurance, a checkup (that answers questions like how much do I need, what type, what company?) will likely offer far greater savings than merely adjusting the payment method. As Peter Drucker said, "There is nothing so useless as doing efficiently that which should not be done at all."
But once you've determined what you really need, if you have enough in savings to pay annually, you'll usually gain more by paying in advance and saving these high interest charges, rather than by earning a taxable low-interest rate in a savings account.
Keep in mind: If paying annually squeezes your savings too much, wait another year and give your savings time to build. Don't undermine the ability of your contingency fund to fulfill its primary function—dealing with unexpected expenses. 
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