Whole Life Dividends: Options for Growth
As November comes to an end, something on the minds of participating whole life carriers and policy owners is dividends. For carriers, they may be wondering what the new dividend rates are, particularly in the face of the coronavirus pandemic. But consumers might be asking a different set of questions: What can you do with your expected dividends? And, why are dividends so important anyway? Well, now more than ever, people are looking for additional streams of income while also seeking out ways to protect themselves from unforeseen events. This is why a participating life insurance policy, which pays dividends to the policy owner that is generated from the profits of the insurance company, might be an attractive option.
Most companies have what I like to term “the core four” dividend options on their participating WL products. These are: Purchase Paid-Up Additions, Paid in Cash, Reduce/Pay Premium, or Accumulate at Interest. Essentially, having dividend options creates versatility and flexibility for consumers. The versatility comes into play when looking at the various ways you can use your dividends. The dividend options are flexible, and carriers will allow policy owners to switch their dividend options during the life of
the policy, as often as annually. This month, we decided to investigate the different dividend options available for selection in the participating whole life market.
Purchase Paid-up Additions
This choice is the default option for all participating whole life policies – and with good reason – since it provides policy owners with the most long-term value. With this option, the carrier takes the insured’s annual dividend and purchases paid-up additional life insurance with it. These paid-up additions (PUAs) function like micro fully paid-up whole life policies that attach to the original policy, but they are funded with dividends as opposed to just premiums. The dividends are essentially a reinvestment back into your life insurance policy for more death benefit and cash value. As you purchase more PUAs, your cash value along with your death benefit increases. Furthermore, these PUAs can also earn dividends as well, which creates a compounding effect. Taking advantage of this dividend option can help an insured achieve their goal of maximum cash value accumulation.
Paid in Cash
Paid in cash is a self-explanatory option. With this dividend option, the policy owner will typically receive their dividends in the form of a check from their whole life policy. An advantage with this is that life insurance dividends usually enjoy special tax benefits since it is considered a refund of the policy premium.
Generally, dividend amounts received over the life of the policy may become taxable at the point when they exceed the premiums paid for the policy. Also, if the policy is a Modified Endowment Contract (MEC) then different taxation rules may apply to the policy dividends. As always, please consult your tax advisor with any questions, as LifeTrends does not give tax advice.*
Policy owners can also use their dividend payments to cover the payment of their premium. In the event the dividend is larger than the premium owed, most carriers offer a secondary option, such as purchasing PUAs or being taken in cash. One important thing to note is that typically, the premium mode must be annual to apply the dividend to it, which might be troublesome for insureds who cannot afford to pay a large sum of premiums at once.
Accumulate at Interest
Here, dividends are reinvested back into the policy, in a separate account with a declared interest rate. While an insured can withdraw the funds from both the interest earned and the dividends accumulated, only dividend payments can be put in the account. The interest rate credited to the account is often very low and is usually not an attractive option for the policy owner to consider. Additionally, it should be noted that the interest earned in accumulated options is taxed to the policy owner on a yearly basis.*
In addition to these core four dividend options, some carriers offer two more: Loan Repayment and One Year Term (OYT). Loan repayment is a straight-forward option: the dividends will be applied to any outstanding loans taken on the policy. However, an interesting but not as commonly available dividend option is using your dividends to purchase term insurance. Purchasing One Year Term insurance is sometimes called the “Fifth Dividend Option” and it aims at being a less complicated way to add additional
coverage. This option allows a policy owner to purchase one-year term insurance subject to a maximum such as two times the policy’s face amount. Since this is not as common of a dividend option, it is not typically available in an illustration.
The dividend options available to the policy owner will be dependent on the life insurance carrier and the exact product chosen. But, ultimately, a policy owner’s decision of which option to select will be based on their unique needs. Are they looking to maximize their cash build-up or wanting to find a less expensive premium for their policy? Are they interested in getting a check to pay off debt or searching for ways to invest their extra income? Whichever need your client is looking to address, it’s important to be educated on how each dividend option functions and help them choose the option that best suits their needs.
*Please consult a tax advisor. LifeTrends does not provide tax advice.