Does Buying Whole Life Insurance from a Dividend Paying Insurance Company Make Sense?

When it comes to life insurance plans, there are various options available, ranging from comprehensive whole life to limited-term policies. Although term policies are generally the most inexpensive type of life insurance, whole life policies offer a variety of advantages that policyholders may want to consider. Some advantages include a guaranteed death benefit, stable premiums over time, and even benefits that can provide tax free cash to pay for anything you need help with or help cover the cost of insurance over time.

Whole life insurance plans usually have a cash benefit that increases with time. However, certain plans offer the possibility of payouts dependent on some variables, like a dividend-paying whole life insurance . Dividend paid whole life insurance from a mutual insurer is a permanent life insurance policy where you are a part owner in the company and each year the company pays you the policy owner a dividend in exchange for a premium payment. These funds may be able to help drive cash-value growth or secure a greater death benefit. But how does this work, and how will it work for you? 

What is a Dividend-Paying Whole Life Insurance Policy?

Dividend-paying whole life insurance helps you to potentially share in the financial success of an insurance firm. Dividend-paying whole life insurance pays dividends if the insurance firm does well financially that quarter or year. Customers may participate (to a limited extent) in the performance of an insurance company under these plans, which are often referred to as “participating.” 

A conventional policy, on the other hand, is often referred to as “non-participating,” since the provider’s success has little effect on the policy’s cash value. Participating whole life policies, go a step further since the policy owner shares in the insurance company’s earnings. The dividends paid are based on the success of the company’s financials that include interest rates, investment returns, and the sale of new policies. 

In the case of dividend-paying whole life insurance, insurers can pay dividends based on the amount of insurance in effect. The more coverage your program has in force, the more dividends you will possibly earn. Dividends may be allocated as cash, used to buy additional paid-up insurance, or used to offset outstanding premiums. Because of the protections offered, whole life insurance acts as a “safe bucket.” 

What Are Dividends? 

Basic Concepts of Dividend Paying Insurance Policies

• There are a few major players in the field of life insurance. 
• The policyholder, the corporation, the insured, and the beneficiary.
• The insured is frequently, but not always, the owner. 
• The policy is a legally binding agreement between the owner and the company. 
• When the insured dies, the insurance provider pays a lump sum death payout to the policy’s beneficiary.

Whole life plans contain benefits such as a guaranteed level premium, a guaranteed death payout for your entire life, and guaranteed cash value accumulation. Many whole life insurance plans pay dividends that constitute a portion of the insurance company’s income to policyholders. These dividends are close to conventional stock dividends in that they constitute a portion of a public company’s earnings.

The size of the dividend is often calculated by the amount of money paid into the policy. For example, a $50,000 policy with a 3% dividend would cost a policyholder $1,500 over the course of the year. If the policyholder contributes another $2,000 in value during the next year, they will earn an extra $60, for a total of $1,560 the following year. These payments will rise over time to cover some of the costs associated with premium payments.

Whole life insurance dividends can be guaranteed or non-guaranteed depending on the policy, so it’s important to read the fine print before buying a policy. Guaranteed dividend plans frequently have higher premiums to compensate for the increased risk to the insurance provider. Those that have non-guaranteed dividends will have lower premiums, but there is a possibility that no premiums may be charged in a given year.

Unlike other types of dividends (such as those from investment products), dividends from a participating whole life policy are usually excluded from income tax. Such fees are usually viewed by the IRS as a refund of unused premiums. However, depending on how you take withdrawals, you can end up owing taxes if you collect more than your cumulative payments into a life insurance policy.

Ultimately, policyholders should consider the insurance company’s credit rating when deciding how sustainable dividends are in the future. The majority of insurance firms have A or better credit ratings from major credit agencies. Those with less than an A rating may require a closer review to decide if the insurance is adequate.

Dividend Payment Options

When it comes to using whole life policy dividends, there are several options available. Options can range from receiving a check in the mail to purchasing extra insurance. Dividends are most widely used for the following purposes: 

Cash or Check: A policyholder may request that the insurer send a check for the dividend amount, which may be taxed. You could spend the money on whatever you wanted. The insurer will give a check or move funds directly to your bank.

Reduce Out-of-Pocket Premium Payments: A policyholder can request that the dividend be applied to future premiums owed in order to offset the cost of the dividend. This reduces the amount you’d have to pay out of pocket. When non-guaranteed policy values are used to minimize out-of-pocket costs, dividends, paid-up extra insurance, and dividends left to collect at interest are used to cover premiums as they become due. You can suspend your out-of-pocket premium payments by using your policy values to make these payments until these values (plus potential values based on the current scale) are calculated to be sufficient to cover each remaining premium.

Accumulate at Interest: You could leave the money with your insurance provider and gain interest on it. Those funds may be eligible for withdrawal or added to the death benefit. You can withdraw your dividends at any time without impacting the guaranteed cash value or guaranteed death benefit of your policy. However, once withheld, accrued dividends cannot be redeposited. Profit received on accrued dividends, like any other interest, is taxable in the year credited and may be subject to income tax withholding.

Additional Insurance: A policyholder can use the dividend amount to buy additional insurance or make a prepayment on their policy. You could also reinvest the dividends in more dividend-paying whole life insurance. This could increase your overall cash worth, which could lead to higher dividend payments. If the insurer continues to pay dividends and you choose this option, you will benefit from compound growth of your cash value as well as a substantially higher death benefit.

Savings Account: A policyholder can opt to keep the dividend in a savings account with the insurance provider in order to gain interest on it.

Since dividends are not guaranteed, there is no way of knowing when you will be able to use policy benefits to minimize your out-of-pocket payments. In fact, the insurance will never hit the point that non-guaranteed policy values are enough to cover your premiums. Please keep in mind that even though you are able to postpone making out-of-pocket premium payments, you may have to restart them later due to dividend changes or if you take loans or withdrawals.

How to Use Dividends 

You can consult with your financial representative on the best way to use dividends for your family. Many tactics are based on the ideas mentioned below. 

Asset Accumulation: By reinvesting dividends and using the paid-up additions option, you can build up additional cash value in your whole life strategy over time. As financial needs occur later in life, the cash value can be available for loans or withdrawals. Policy loans, on the other hand, accrue interest, may result in an income tax liability, may decrease the policy’s account value and death benefit, and may even cause the policy to expire.

Leaving a Legacy: Once again, the paid-up addition option will result in a will death benefit if dividends are re-applied over many decades. As a result, your beneficiaries could be entitled to a higher death payout from your policy than they would have been if you hadn’t re-applied your dividends. 

Remember that dividend-paying whole life insurance plans are designed to allow you to eventually share in the financial performance of your insurance provider. If all goes well, you will be able to withdraw funds or reinvest them in your policy, depending on your financial needs and goals. However, there is no guarantee that such a policy will ever pay dividends, so you may want to start with the coverage you need and consider dividends as a bonus.

The good news is that dividend payments from participating life insurance plans are not taxed by the Internal Revenue Service (IRS). This is because the insurance firms generate the profits from their policyholders. In essence, dividend payments are considered as premium overpayment refunds. This implies that taking the cash or check from dividends and reinvesting the proceeds in an investment vehicle that might generate more profits is typically the better choice.

Are Dividends Guaranteed?

No, they are not. Variables change and the amount distributed as dividends can be greater or lesser than the amount distributed in previous years. Providers cannot guarantee your policy’s dividends in advance or guarantee that the dividend scale illustrated when your policy was issued will remain in place. The dividends on your policy can fluctuate over time as new knowledge becomes available. 

What is a Dividend Scale?

A dividend scale is a policy’s entire collection of dividends. The dividend scale for your policy includes the current year’s dividend as well as the dividends the provider will pay in each subsequent year if current experience variables remained constant. When experience factors undergo significant changes, a new dividend scale is introduced.

What Effect Would a Shift in the Dividend Scale Have On My Policy Value? 

The response depends on whether the principles of your policy are guaranteed or non-guaranteed. Guaranteed values are those stated in the policy, such as the guaranteed death benefit and guaranteed cash values. These are the “contractual minimums” that the organization promises to pay. 

If you pay the premiums on time and make no insurance loans, the policy’s death benefit and cash value will never be less than the guaranteed values, regardless of how dividends fluctuate over time. In other words, dividends have no impact on guaranteed values. Surrenders, withdrawals, and loans may impact the value of your policy and the death benefit, and can result in tax consequences.

Absolute cash values and total death benefits, on the other hand, are not guaranteed policy values. The non-guaranteed values seen in an illustration are based on the dividend scale in place at the time the illustration is made. With the exception of premiums, this ensures that each of the values not called “guaranteed” are based on the expectation that today’s dividend scale will continue into the future for all years shown.

A shift in the dividend scale would affect your non-guaranteed values unless you receive your dividends in cash. If dividends rise in a given year, your policy’s overall cash value and total death benefit are likely to rise above what was previously seen. On the other hand, if dividends fall, these values might be smaller than previously illustrated.

In Summary 

A well-crafted dividend based whole life insurance policy is also an excellent tool for building capital and leaving a legacy. The aim of optimizing cash value growth in a whole life policy for wealth accumulation is to allow the policy owner to: 

• Take out loans against the cash value to buy other assets and/or recapture debt from expenditures, while the cash value in the policy continues to rise simultaneously through tax-advantaged accumulation. 
• Create a “Safe Bucket” to serve as the base for your wealth-building path. 
• To maximize growth potential, policy allows for true compound interest growth in a tax-deferred setting.

Many whole life insurance plans pay policyholders’ dividends that can be used in a number of ways. Individuals should examine how dividends are measured. They should also examine whether or not dividends are guaranteed when reviewing insurance plans, as well as how they plan to treat dividend income. Because of the favorable tax treatment, the better choice is typically to take the cash and spend it elsewhere for a higher profit.

Mutual insurance companies that offer to pay participating policyholders a dividend is the best route for whole life insurance. However, not all life insurance policies pay out dividends. Whole life is the only form of permanent life insurance that pays dividends. Dividends are not guaranteed, but most insurance providers that sell these forms of life insurance plans have paid dividends on a regular basis for the last 100 years or so.