Dividend Paying Whole Life Insurance: Is It Right for You?

If you’re looking to protect your family’s financial future, you might consider dividend paying whole life insurance as an option. This type of insurance is widely owned in the U.S. and has its own set of strengths and weaknesses.

In this article, we’ll go through everything you need to know about dividend paying whole life insurance and if it’s the right type of whole life insurance for your needs.

What is Dividend Paying Whole Life Insurance?

Dividend paying whole life insurance is a type of permanent life insurance policy that not only provides lifelong coverage but also has a cash value component that can grow over time. This type of policy is offered by mutual insurance companies, which are owned by their policyholders. 

Permanent Coverage

Whole life insurance provides permanent coverage throughout your lifetime, unlike term life insurance, which expires after a specified period. As long as you continue to pay the premiums, your whole life policy remains in effect, ensuring that your beneficiaries receive a death benefit whenever you pass away.

Cash Value Accumulation

A significant feature of whole life insurance is its cash value accumulation. A portion of the premiums you pay goes into a cash value account, which grows over time at a guaranteed rate set by the insurance company. 

This cash value serves as a savings component within the policy and accumulates tax-deferred. You have the option to borrow against this cash value or use it to pay future premiums, providing financial flexibility and potential liquidity during your lifetime.

Dividends 

One of the unique features of this policy is the potential to receive dividends. These dividends are a portion of the insurance company’s profits distributed to policyholders. They are not guaranteed but can be a valuable benefit if the company performs well.

Understanding Dividends on Whole Life Insurance

Dividend paying whole life insurance policies offer more than just a death benefit; they also have the potential to pay dividends. These dividends, which are a portion of the insurer’s profits, can provide significant financial benefits over time. 

What are Dividends?

For whole life insurance policies, dividends are a small share of the insurer’s profits. These dividends function similarly to those distributed by public companies. The dividend amount usually depends on the premium paid into the policy. 

For example, a $100,000 policy with a 5 percent dividend rate will yield $5,000 annually. If the policyholder contributes an additional $5,000 the following year, the dividend will increase to $5,250. Over time, these payments can grow enough to help cover the costs of maintaining the policy.

Dividends can be either guaranteed or non-guaranteed. Policies with guaranteed dividends often come with higher premiums, while non-guaranteed policies tend to have lower premiums but might not pay dividends consistently. 

If dividends are a key factor for you, consider the insurance company’s financial rating. Companies with excellent ratings are typically more capable of reliably guaranteeing and sustaining dividend payments. Therefore, you may prefer insurers with a rating of A or better.

How to Use Dividends

When you receive your dividends, you have several choices for how to use them. You can request a check and deposit the funds into your account. Alternatively, you can apply the dividends to reduce a portion of your premium or buy additional insurance coverage. 

Another option is to leave the dividends with the life insurance company, where they can earn interest. Dividend payments can also be used to decrease the balance of any loans taken against your policy’s cash value.

Dividends’ Effect on Premiums

Dividends reflect the insurance company’s profits derived from policy premiums. You can apply these dividends to cover all or part of your premiums, thereby reducing the amount you owe or potentially paying off the policy entirely over time.

How Do Dividends Work?

At its core, dividend-paying whole life insurance functions like any whole life insurance. You pay premiums for lifelong coverage, which includes a cash value component. You can borrow against this cash value to access funds, but any unpaid loans will be deducted from the death benefit when you pass away. 

With a dividend-paying policy, you receive dividends if the insurance company has a profitable year. Your agent or financial advisor should provide policy summaries to show projected annual dividends for each policy you consider.

Tax Treatment of Whole Life Dividends

One of the most attractive features of whole-life dividends is that they are often not subject to federal income taxes. For tax purposes, dividends are considered a return of premium by the life insurance company and are taxed similarly to other distributions. These dividends remain income-tax-free until the total amount you’ve invested in the policy is fully recouped. 

For instance, if you have a $100,000 whole-life policy and over the years you receive $100,001 in dividends, only that last dollar would be subject to income tax. Essentially, dividends are a tax-free refund of the premiums you have overpaid.

Getting Tax-Free Income from Whole Life

Dividends are not considered taxable income as long as the total dividends received do not surpass the cost of your policy. Since dividends are issued only when your insurance company has a financial surplus, the IRS views them as a refund of excess premium payments. 

However, if you choose to leave your dividends with the insurer to accumulate interest, that interest will be taxed as income.

How Are Dividends Calculated?

To calculate a whole-life dividend, the insurance company first assesses whether its financial performance for the fiscal year surpasses its projections. This involves evaluating the assets needed to maintain its capital position and overall performance. If the results justify paying dividends, the company then examines each eligible policy. 

Various expenses and credits are factored in to determine the policy’s Guaranteed Accumulated Value. Key statistics include the company’s investment returns and the mortality expense (claims experience) from the previous year. The company then applies the premium percentage to this figure.

Are Dividends Guaranteed?

Dividends in whole-life insurance can either be guaranteed or non-guaranteed. Guaranteed dividends typically come with higher premiums because they obligate the insurance company to pay dividends regardless of its financial performance. However, if receiving dividends is a priority for you, the higher cost may be worthwhile.

Some insurance companies employ a dividend scale alongside dividend calculations. This scale outlines the dividends payable in the current year and projects future dividends assuming no alterations in the current calculation factors. If significant changes occur in expenses, the company will update and distribute a new dividend scale.

Should You Pay Premiums with Dividends?

You have the option to use dividends to cover your premiums, but opting for cash in hand offers greater flexibility. As long as dividends are expected to remain income-tax-free, receiving them directly is likely the preferable choice.

Will You Pay Income Tax on Your Dividends?

If your total dividends received do not exceed the total payments made for the policy, the dividends are considered a refund of excess premiums and are therefore not subject to income tax.

Impact of Change on Dividend Scale

In guaranteed dividend-paying whole life insurance policies, you are assured to receive at least the minimum dividends as long as you have no outstanding loans and keep up with premium payments. These dividends do not alter the guaranteed cash value or death benefit of your policy.

Conversely, for non-guaranteed policies, both the cash value and death benefit can fluctuate. If you were provided with an illustration, it was based on the dividend scale applicable at that time. Any changes to the dividend scale will accordingly adjust the values within your policy.

Effect of Loans on Dividends

The presence of an outstanding loan can influence the dividends earned on your policy, depending on its terms. Insurance companies employing direct recognition methods adjust dividends to account for funds not directly invested due to these loans. Loans also affect the cash value of your policy and the death benefit payable to beneficiaries.

Choosing Dividend Paying Whole Life Insurance: Is it Worth It?

Understanding the complexities of how dividends impact policy value and financial planning requires careful consideration and often professional guidance to navigate effectively. A licensed insurance professional with broad experience in retirement financial issues can help you make these decisions. To help you understand more about dividend paying whole life insurance, here are the pros and cons:

Pros of Dividend Paying Whole Life Insurance

Dividend paying whole life insurance offers several advantages. Firstly, it provides a guaranteed cash value that accumulates over time, offering a stable source of funds that policyholders can borrow against when needed. This cash value also serves as a financial safety net, ensuring beneficiaries receive a guaranteed death benefit upon the policyholder’s passing. 

Moreover, these policies may distribute dividends, which can be used to offset premiums, purchase additional coverage, or accumulate with tax-deferred interest. From a tax perspective, dividends are often treated favorably as a return of premium, potentially making them income-tax-free if they do not exceed the total premiums paid.

Cons of Dividend Paying Whole Life Insurance

However, there are notable drawbacks to consider. One significant disadvantage is the higher premiums associated with guaranteed dividend policies compared to non-guaranteed alternatives. This can make it more expensive to maintain coverage over the long term. 

The growth potential of cash value within these policies is also typically limited compared to other investment options like stocks or mutual funds. There is also the risk that non-guaranteed policies may not consistently pay dividends, depending on the insurer’s financial performance and market conditions. 

Ensure the Life Insurance Company Has a Good Track Record

Since you are looking for dividend payments over the life of your policy, and these payments are only guaranteed by the claims-paying ability of the issuer, make sure that your insurance company has a solid financial history. 

Otherwise, you may get to retirement and find you have never received a premium. Or what’s more, the death benefit on your policy may at that point be in question.

Find the Right Insurance Professional for Your Goals

When seeking assistance with a dividend paying whole life insurance policy, it’s advisable to collaborate with an independent agent or financial advisor. Unlike financial advisors who may represent specific insurance companies, independent advisors offer products from multiple carriers. 

This independence grants them the flexibility to thoroughly research and recommend solutions tailored to their specific needs without being bound by quotas or obligations to a single financial entity.

Need Expert Guidance?

For personalized financial advice, connect with a professional today. Visit our “Find a Financial Professional” section to get started. If you prefer a personal referral for your first appointment, call us at 877.476.9723 or contact us here to schedule a meeting with a trusted and licensed independent financial professional.

🧑‍💼 Authored by Brent Meyer, founder and president of SafeMoney.com. With over 20 years of experience in retirement planning and annuities, Brent is dedicated to helping you secure your financial future. Discover more about his extensive expertise here.