You always hear us talking about dividend-paying whole life insurance whole life insurance designed for cash value accumulation. But what exactly is dividend-paying whole life insurance? Today we’re going to do a deep dive into that exact topic.
Let’s start with the basics. What is a whole life insurance contract?
A whole life insurance policy includes two fundamental promises from the insurance company. First, they promise to pay a death benefit at any point along the way, as long as the policy is in force. Second, they promise that the policy will have a cash value equal to the death benefit at the policy’s maturity age, typically age 100 or 121.
With this structure, you’re getting perfect compounding. In order for the insurance company to fulfill the second promise cash equal to the face amount at maturity they must put aside more money this year than they did last year, and even more next year than this year. That creates a compounding curve starting from zero and building toward the full face amount. So, you’re already earning interest.
But dividend-paying whole life insurance adds a second layer of earnings: the profits of the insurance company. When you purchase a policy from a mutual insurance company, you participate in those profits. That’s why it’s also called participating whole life insurance. If the company earns a profit, you receive a portion of it in the form of dividends, paid out on your policy’s anniversary date.
With a participating whole life insurance policy, the company essentially charges more than needed for the premium, then returns that excess to you as a dividend. These are tax-favored dividends, meaning they don’t typically show up on your tax return. They’re technically considered a return of overpaid premium.
This tax treatment exists because of the lobbying efforts of the life insurance industry. Way back in the early 1900s, when the tax code was developed, the life insurance lobby pushed Congress to recognize dividends as a return of premium not income. That’s why they maintain this tax-advantaged status today.
To maintain that benefit, it’s important to pay your premiums with after-tax dollars. As long as the money stays within the policy or even if you take the dividends as cash they grow on a tax-favored basis.
That’s the foundation of dividend-paying whole life insurance.
Now, how can those dividends increase?
There are two main ways, one of which is in the control of the policyholder, and the other in the hands of the insurance company.
As a policyholder, you can increase dividends by purchasing paid-up additions a feature often referenced online. This rider allows you to put more money into your policy and buy additional paid-up life insurance. If you’re working with a mutual insurance company that earns a profit, a portion of those profits will be returned to you through additional dividends. Because when you own a policy from a mutual insurer, you are effectively an owner of the company as it relates to your policy. So any profits the company earns are returned to you, tax-favored, via dividends.
The companies we work with have paid dividends for over 120 consecutive years, including through depressions, recessions, world wars, gas crises, and tariffs. Think of all the turbulence of the past century yet these companies have continued to pay.
We work with these longstanding, reputable mutual insurance companies because they have consistently rewarded policyholders and provided access to cash value not just at death, but throughout life.
The second way dividends can increase is based on the insurance company’s profitability. That’s why it’s important to choose a company with not only a long history of paying dividends, but also a strong underwriting process. You don’t want them insuring people indiscriminately. To ensure profitability, reputable companies require an application, medical questions, and often a physical exam. The more selective the company, the more financially stable they are and the more reliable those future dividends will be.
Now let’s talk about what could reduce your dividend: policy loans. Some companies penalize your dividend amount if you have an outstanding loan. This is called direct recognition.
In our opinion, it doesn’t make much sense to penalize someone for using their policy the way it was intended to borrow against cash value. We prefer to work with companies that use non-direct recognition meaning the net cash value is not factored into the dividend calculation. The policy will perform as intended whether or not you have a loan.
With direct recognition, the insurer calculates dividends based on net cash value (cash value minus loan balance). So, if you have no loan, your dividend may be higher. If you do have a loan, it might be lower.
The common argument in favor of direct recognition is that it’s “fair.” For example, if one policyholder has a loan and another doesn’t, some believe the latter should earn a higher dividend. But we challenge that logic.
Imagine this scenario: You have a 4% CD at a bank. Two years into the CD term, you go to the same bank for a car loan. A month later, you see your CD rate has dropped. You call the bank and ask why. They tell you it’s because you now have a car loan. That doesn’t make sense and neither does reducing dividends for having a policy loan, especially since the insurance company is still charging interest on the loan.
Whether it’s direct or non-direct recognition, the insurer is earning interest on the loan. So, there’s no reason to penalize the policyholder. To us, direct recognition feels like a money grab even though mutual insurers eventually redistribute profits. On principle, it doesn’t add up, and we aim to avoid it when possible.
Some companies use direct recognition, and some do not. As a policyholder, you can’t control this after the policy is in force so it’s a decision you want to make before choosing your insurer.
In conclusion, dividend-paying whole life insurance policies are issued by mutually owned insurance companies and offer long-term guarantees plus the opportunity to share in company profits.
If you’d like to learn how to put a specially designed whole life insurance contract to work for your family, your business, and your specific situation, visit our website at www.tier1capital.com and click the “Schedule Your Free Strategy Session” today.
Thanks for reading, and remember it’s not how much money you make, it’s how much money you keep that really matters.