When it comes to financial security and peace of mind, whole life insurance is always at the top of the list. While many people are aware of the primary benefits of whole life insurance — increasing cash value and permanent coverage —fewer understand the true potential that lies in the dividend options that come with these policies. If you currently have a whole life insurance policy, or you’re considering one, it’s crucial to know how you can maximize the advantages of your dividends.
What are whole life insurance dividends?
Dividends are a portion of the insurance company’s profits that are returned to policyholders. Unlike traditional insurance policies, whole life insurance is uniquely designed to accumulate cash value over time and generate dividends based on the insurer’s financial performance. These dividends can significantly enhance the overall benefits of your policy, providing you with flexibility and financial growth.
Here Are The Various Whole Life Dividend Options
Paid-Up Additions: One of the most popular options is to use your dividends to purchase paid-up additions. Paid-up additions are mini whole life insurance policies that attach to the main whole life policy. They earn dividends themselves and have immediate cash value. This strategy allows you to increase your policy’s death benefit and cash value without the need for additional premium payments. By choosing paid-up additions, you effectively boost your cash value in the policy, which can significantly pay off over the long term.
This dividend option will ensure the most bang for your buck in terms of premiums generating cash surrender value. Put another way, if you seek to maximize the cash value buildup of your whole life policy, then the option to purchase paid-up additions is the dividend option you seek.
This dividend option is also how whole life policies accumulate non-guaranteed cash value. The non-guaranteed cash value of a whole life policy is simply the cash value created through paid-up additions. This “non-guaranteed” cash value is the only cash value that the policyholder can withdraw from a whole life policy.
Cash Payout: If you’re looking for immediate liquidity, opting for a cash payout is a viable choice. This option gives you access to cash that you can use for any purpose — from paying down debt to funding a family vacation or investing in new opportunities. This flexibility can be a game changer, especially during unexpected financial moments.
An example will help clarify this concept.
Michael owns a 15-Pay whole life policy with a cost basis (total premiums paid minus total withdrawals made) of $150,000 after 15 years. He opted for the cash payout dividend option. Once the insurer pays Michael an aggregate $150,000 in dividends, Michael will need to report all future dividends as taxable income.
Also, note that if dividend payments remove the cost basis, any withdrawals from the policy will cause a tax liability as well. Policy loans continue to enjoy tax-free status so long as the policy does not violate the Modified Endowment Contract rules.
Reduce Premiums: Another smart choice is to use your dividends to reduce your annual premiums. This can help ease your financial burden, ensuring that your insurance remains affordable while allowing your policy to continue growing. It’s a sharp way to maintain coverage while managing your cash flow effectively.
Choosing to reduce or pay premiums with the dividend means the policyholder chooses to pay a part or all the premium due with the dividend. If the dividend payment is less than the total premium due, the policyholder will need to pay the rest of the premium either with money out of pocket or with cash values from the whole life policy. It’s much more common for the policyholder to pay with out-of-pocket money.
Once the dividend payment equals or exceeds the premium due amount, the dividend can pay the entire premium due and the policyholder does not need to make any payment to the policy with any out-of-pocket money. It’s common to see older whole life policies using this option as the policyholder can keep his/her death benefit in force without having to pay the premium on the life insurance policy.
Choosing this option does come with some consequences that all policyholders should understand.
First, the insurance company will require the policyholder to change the payment frequency to annual if it’s not paid annually already. This is important for policyholders who pay premiums under some other frequency as it could cause a cash flow problem. An example will help highlight this point.
Imagine that Ashley owns a whole life policy with a $1,500 per month premium she pays. She decides that she wants to use the reduce premiums option. In the year she makes this decision, the annual dividend on her whole life policy is $6,000. The annual premium for her policy is $18,000. Choosing the reduce premiums option means Ashley must change her payment frequency to annual. Her dividend will reduce the premium due to $12,000, which is due in one lump sum. If Ashley does not have the $12,000 to pay the premium all at once, the reduce premiums dividend option is not a good idea for her.
Though the dividend payment is a refund of premium, using the dividend to pay ongoing premiums due creates an offset that leaves the tax basis static in all years a policyholder uses this option. This means the cost basis will neither go up nor go down while using the dividend option to pay premiums.
If the dividend is smaller than the annual premium, any payment made with out-of-pocket money will increase the cost basis of the policy.
It’s also worth noting that dividend payments can and do fluctuate. Therefore, if the dividend payment covers your entire premium this year, it might not next year. We bring this up because life insurance illustrations assume a constantly increasing dividend due to the assumption that the dividend scale remains static. This is not how most whole life policies work in real life. Dividends do tend to grow substantially over time, but that growth is not always linear.
Lastly, know that this dividend option is somewhat unique given that there is a limit to the amount of dividend applied to this option. Once the dividend is larger than the premium due on the policy, the excess amount must go somewhere. For example, if you have a $18,000 annual premium and the dividend for the year is $25,000, you have a remaining $7,000 that cannot go towards paying the premium. In this case, the policyholder must choose a secondary dividend option. Simply, he or she will choose one of the other remaining dividend options and the $7,000 will go towards that option.
Accumulate At Interest: Some policyholders prefer to let their dividends accumulate at interest within the policy. This option allows your dividends to grow tax-deferred, contributing to your policy’s cash value. This means your dividends not only work for you but can compound over time, enhancing your overall financial portfolio.
Using this option means the insurance company places the dividend payment in an interesting-bearing account and adds an interest payment to the account each year. The insurer sets the interest rate on these accounts every year. The rate can change annually, but all insurers establish a minimum guaranteed rate on these accounts.
The policyholder cannot choose to place additional funds into the interest account. Only dividend payments can go to the account.
The policyholder is free to withdraw funds from the interest account whenever he/she sees fit. But he/she will not have the option to put the money back into the account later. Once removed, the only way to build the account back up is through future dividend payments on the whole life policy.
You should understand that the interest account is not part of the life insurance policy and does not benefit from the tax-friendly treatment associated with cash value life insurance.
Interest earned under this dividend option incurs an income tax liability just like interest earned on any other cash equivalent account held at a bank or financial institution. The policyholder will receive a 1099-INT at the end of the year reporting all interest paid and must file this with his/her taxes.
The life insurer will not issue a policy loan against the interest account. The values accumulated can only be withdrawn.
The Fifth Dividend Option: As insurers evolve and become more creative with product design, a “fifth” dividend option appeared that is quite common–though not as universal as the four options mentioned above.
This life insurance dividend option allows the policyholder to use the dividend to purchase term life insurance. This option is commonly the most efficient way to build death benefit with a whole life policy – at least in the short term.
The exact execution of this option varies from company to company. The type of term life insurance purchased is not universal across companies. The amount of term life insurance a dollar buys can vary from company to company and will change as the insured ages.
Purchase A Blended One-Year Term Convertible Rider: Some mayor life insurers offer this option. This option reduces the cost of the death benefit necessary to avoid a Modified Endowment Contract (MEC) by offering a one-year term that converts to whole life insurance and achieve the necessary death benefit target. This option is common to generate efficient and high cash value policies.
Other less common options include Long-Term Care benefits option, Index Credit option and Charitable Giving option if you have those riders in your policy.
If you would like to learn how you can grow a substantial amount of cash that you have access to at any time without penalties, is unrelated to the stock market, and will generate income that is not included in your tax return, visit our website at http://InfiniteBankingSimplified.com/ or feel free to email us your questions at ContactUs@InfiniteBankingSimplified.com or call us toll-free at 1-844-443-8422.
Isis B. Palicio, LUTCF, MBA
Pedro A. Palicio, MBA, Ph.D.
Infinite Banking Concepts® Authorized Practitioners
We are experts in designing high cash value dividend-paying whole life policies.