In the world of life insurance, mutual insurers offering dividend paying whole life insurance are somewhat of a unicorn. While these companies do exist, the modern era has seen many companies go the way of the stock market. But it is important to understand that..
Not all life insurance policies are created equal.
Some policies, such as term life insurance or guaranteed universal life, are focused mainly on providing a death benefit. You can call these policies “pure” insurance. Another name would be “death” insurance, since the focus is on providing for the insured’s beneficiary upon the death of the insured.
Other policies are structured to accumulate cash value in the life insurance policy. The top 10 best life insurance policies are true “life” insurance, since the first beneficiary of the policy is you—the insured—during your life, and not only after you have died.
Among the cash value accumulation crowd, only some carriers and policies pay life insurance dividends to policy holders. This is important because life insurance dividends offer some unique opportunities. This article will review all that you need to know about life insurance dividends.
Characteristics of Dividend Paying Life Insurance
Dividend paying whole life insurance is almost always participating whole life insurance from a mutual company. More specifically defined as a:
- A participating life insurance policy,
- Designed as a whole life insurance policy,
- Through a mutual life insurance company
Participating Life Insurance Contracts and Dividends
The term “participating” may sound a bit more complicated than it really is. Thinking about life insurance as a contract, you agree to pay the insurance company to provide a certain amount of money to your beneficiaries upon your death.
To participate in this contract means that the policy holder shares in the profits and losses of the company during his/her lifetime. Sharing in the profits is a huge part of what receiving life insurance dividends is all about.
Whole Life Insurance and Dividends
Participating life insurance contracts are whole life insurance policies, typically from mutual insurance companies, though some stock companies do offer life insurance dividends.
With whole life insurance, the premium amount is fixed as is the initial death benefit.
Eventually the policy is paid up at which point the death benefit becomes permanent (or not subject to lapsing).
Cash value accumulation in a whole life policy can also be enhanced through what is called life insurance policy paid up additions up to certain maximums that are close to, but not exceeding MEC life insurance policy limits.
With this in mind, dividends are a return of premiums (to the policy holders) which have been “overpaid” in a sense because the company has shown a profit at year end. This sharing of profits also relates to the policy holders being the owners in a mutual company verses a stock company.
Since dividends are considered return of premium under our tax code, life insurance dividends are not taxable. This is great news and one of the biggest benefits of whole life and why you will find that banks, corporations and the wealthy almost all have whole life insurance.
Mutual Life Insurance and Dividends
A mutual life insurance company is owned by the policy holders (or owners) verses a stock company which would be owned by the shareholders. Mutual insurance companies operate primarily for the benefit of its owners (policyholders). In contrast, stock companies operate for the benefit of its shareholders, which may not always align with the best interest of policyholders.
Essentially, to pay and receive a life insurance dividend is saying that the policy holder overpaid on the premiums and that the company performance exceeded expectations.
So, after all expenses, the company concluded that dividends should be paid for overages. The return of premium is also the basis for a key tax advantage of dividends.
Key Features of Life Insurance Dividends
- Offers tax advantaged growth
- You can determine how they are used
- May or may not be guaranteed
Tax Advantaged Growth and Dividends
In a previous article focusing on the tax advantages of life insurance, we discussed that the cash value accrual in a life insurance contract is allowed to accumulate tax free inside the policy.
We also mentioned that no taxable income (or capital gain) is realized for amounts that do not exceed the total amount of premiums paid into the policy.
Finally, we mentioned that income is only realized when cash is actually withdrawn from the policy, and/or the policy is surrendered, and proceeds exceed the premiums paid. These advantages are a feature of all cash accruing permanent life insurance policies.
With all of the above in mind, dividends offer an additional tax advantage because, when paid, dividends are not recognized as taxable income. So whether the dividend is withdrawn as cash or rolled back into the policy, favorable tax treatment allows for more compounding tax advantaged growth.
Tax favorable growth through dividends is a key aspect of the infinite banking concept® which incorporates the velocity of money and the idea that your money should always be moving, earning and growing. Follow any of the above links for more, but realize that you need to keep your money moving if you truly want to gain wealth. Stagnant money, such as funds in a 401k, is dead money.
Freedom to Decide How Dividends are Used
Most dividend paying life insurance policies offer the policy holder the right to choose how to use dividends. Usually the choices for using life insurance dividend payments are:
- Apply toward the next year’s premium payments
- Buy additional term life insurance
- Apply toward repaying outstanding policy loans
- Purchase additional whole life insurance
While the above choices are mostly self explanatory, the last two are somewhat near and dear to fostering wealth building with life insurance.
The first 2 choices (#1 and #2) above focus on either maintaining the policy in force OR a preserving maximum death benefit, whereas the last 2 choices are preferred in many cases because they facilitate the ongoing performance and growth of the policy cash value.
Applying Dividends to Policy Loan Repayment
One of the central components to infinite banking is to pay back policy loans, like a business, with interest just like you would to any other third party lender. This not only covers the interest rate fixed by the insurance company but can allow for additional cash value growth due to additional amounts paid back into the policy, or to fund a new policy if your existing policy is at its limits.
Purchasing Additional Whole Life Insurance
Using dividends to purchase additional paid up whole life insurance is a way to systematically increase both cash value and death benefit in the same way as paid up additions would do so without violating the MEC rules for life insurance contracts.
By growing your cash value and death benefit you will be maximizing your legacy because your policy will pay an ever increasing death benefit to your future heirs upon your passing, unlike term life that will most likely expire worthless. It is also superior to other types of permanent life insurance where the death benefit remains the same and never has a chance to grow with you.
Thus, it makes sense to roll the dividends back into the policy by purchasing additional whole life insurance so that your cash value grows, compounded by a guaranteed interest rate and dividend growth and your death beenfit grows, so you leave as much money as possible to your estate.
Dividends Are Not Guaranteed
Dividend paying whole life polices have a guaranteed portion and a non-guaranteed portion of the policy return, and dividends are part of the non-guaranteed portion.
Typically, the death benefit and an annual return on the cash value is guaranteed. The payment of dividends is part of the non-guaranteed portion of the policy contract. The likely reason for this non-guarantee, despite the astounding history of life insurance dividend payments by major carriers, is that dividends can only be calculated after the expenses for the year are deducted.
Still, it is highly recommended to look at the historic performance of your chosen companies when evaluating between various dividend paying life whole life companies. Many of the top mutual companies have paid dividends for over 100 years, paying dividends to policyholders even during the Great Depression, and more recently during the Great Recession.
Dividend Paying Life Insurance vs. Other Permanent Life Insurance
We already briefly mentioned who the winner is in the saga between whole life vs term life insurance.
However, tt would be a shame to get this far in our discussion and yet fail, as many have, to point out the other kinds of permanent life insurance that do NOT pay dividends. Namely, the genre of permanent life insurance known as universal life policies DO NOT pay dividends (at least to my knowledge to date).
There are a few reasons for this as follows.
- Universal life policies are not participating
- Universal life policies offer market based returns
- Universal life policies do not fix premiums (usually)
The best example, and most popular type, of universal life policy is indexed universal life. Even if a universal life product is offered by a mutual company, these policies do not operate by the same rules as a whole life product. By definition these are NOT participating policies because a different formula, and philosophy, is applied when calculating the policy returns.
Market Based Returns
Whereas a participating whole life policies offer minimum guaranteed returns, with a non-guaranteed potential return based upon company performance, indexed universal life policies offer a maximum guaranteed return based upon the performance of any number of selected market indexes. So performance is tied to the financial markets rather than the performance of the mutual life insurance company directly.
No Fixed Premiums
Another important difference between dividend paying whole life policies VS universal life policies is that the former is a “fixed premium policy”, whereas universal policies are known for offering flexible premium payments.
Remember that a dividend is based upon a return of premiums paid and in the world of universal life, payments may be extremely inconsistent from policy owner to policy owner.
Perhaps this is another underlying philosophical difference between participating and non-participating policies. Because the premiums aren’t fixed, or required to be fixed, the participation aspect of the policy gives way to the element of flexibility. However, what appears to be the trade off is the loss of opportunity for dividend payments.
Why would this matter?
One of the greatest benefits of whole life insurance is its stability. In a world of change, our financial foundation should have a “safe bucket” from which we can go to avoid the often chaotic atmosphere that surround most of our investments.
Whole life insurance is a stable asset from which you can brave the stormy seas, free from the emotional drain that all too often capsizes our best laid plans, sinking our financial vessels to the bottom of the sea.
If you have questions about dividend paying life insurance or anything having to due to strategic life insurance or estate planning, I encourage you to connect with us today.