Understanding Life Insurance Dividends
With all of the stock market volatility and low-low interest rates, there has been a resurgence of interest in dividend-generating assets. Most people think of stock dividends, but stocks aren’t the only asset that can generate dividends.
For those looking for a good “safe money” option, we recommend dividend-paying life insurance! In this article, we’ll address:
What are life insurance dividends and how do they work?
What kinds of companies pay dividends?
Are life insurance dividends taxable?
What are your life insurance dividends options?
And more.
Essentially, we’ll try to answer “everything you always wanted to know about life insurance dividends but were afraid to ask!”
What are life insurance dividends?
Mutual Life Insurance companies share their profits with participating policy holders. They do so via a dividend. This dividend is declared annually, usually around the end of the calendar year. You may have seen announcements about 2020 dividend payouts. Many companies declared their biggest dividend payouts ever, including:
Northwestern Mutual, which paid policy holders $6 billion in 2020, up from $5.6 billion the year before.
New York Life paid eligible participating policy owners a record dividend payout of $1.9 billion.
MassMutual (Massachusetts Mutual) made dividend payments to $1.7 billion.
Guardian Life paid policy owners a $982 million dollars in dividend this year, also a record payout.
Note this dividend is listed as a dollar figure and only sometimes an interest rate (more later on the latter).
Dividends represent profits are paid to policy holders annually. We’ll cover dividend options below.
What kind of life insurance pays dividends?
Dividend-paying life insurance is almost always whole life insurance from a mutual company such as Guardian, MassMutual or New York life, to name some of the better-known mutual insurance companies. (MetLife is an exception… they have demutualized but still pay a small dividend.)
Mutual companies, as opposed to stock companies, are companies owned by the policy holders rather than shareholders of company stocks.
Whole life insurance that pays dividends is also known as “participating life insurance,” or a “participating policy contract.” That simply means that the policy owners “participate” in sharing in the profits of the insurance company. Participating policies are whole life policies that pay dividends.
Term life insurance, universal life insurance, and variable life insurance policies do not pay dividends. (Term life purchased from a mutual company is not a participating policy.)
How do dividends from a life insurance company differ from other dividends?
The word “dividend” causes confusion because it is most often used in connection with a public company paying a stock dividend. If you own stock in a public company that pays dividends, you might receive a quarterly check from the company. Stock dividends could also come in the form of additional shares rather than cash. Dividends represent corporate earnings and are determined by a company’s board of directors.
Life insurance dividends also represent earnings. However, mutual life insurance companies, by law, must share ALL profits of the company with participating policy holders. Profits over and above monies set aside for legacy benefits and operating expenses are distributed back to policy holders in the form of dividends.
If dividends are paid and reinvested into the policy as paid-up additions, they become part of the guaranteed cash value and part of a new, higher basis or floor that increases future gains—both guaranteed gains and dividend payouts. Cash value can never lose value is guaranteed to grow by at least a minimum guarantee. Therefore reinvested dividends cannot be lost due to a stock market downturn. And any dividends paid and reinvested ensure that any future cash value gains and dividend payouts are actually increased!
Compare this to a stock dividend: most people re-invest their stock dividends and if the price of the stock goes down after that reinvestment, you have essentially “lost” your dividend, or must wait for the price of the stock to go back up in order to recover your dividend. (Of course you can take dividends in cash in which case, you wouldn’t lose it.)
In this podcast episode, Todd Strobel and Kim Butler discuss the difference between publicly-traded company dividends and life insurance dividends: “In-Depth on Dividends.”
What does the declared dividend interest rate mean, exactly?
Annual announcements of dividends are usually accompanied by the announcement of an interest rate, as well. This represents the dividends as a “gross” interest rate.The actual dividends distributed are reduced by the three areas of expense inside a whole life policy: the mortality cost, commissions, and the expenses of running the mutual company.
It is tempting, yet not necessarily helpful to compare “gross dividend rates” from one company to another. This gross rate does not have meaning to the individual policy holder. The only thing that has meaning is the net rate (after the three expenses listed above) and the only software I’ve seen that identifies the next rate is available at TruthConcepts.com. (Full disclosure, I’m married to its creator, Todd Langford.)
For example, my mutual company may say its 2019 dividend is 5.9%. That is, as Todd likes to say “just a fun fact”. In order to figure out how much my cash value is growing this year (or over a period of years, which is more meaningful) I must use the Life Values tool and the Funding calculator to analyze this.Then I can tell from that work that my cash value is growing this year at an average rate of 3.9. (This will be similar to yours, give or take a bit for age and gender.) In other words, by the time it reaches my pocket or policy, the gross dividend is reduced by around 2% of costs.
This discussion should include the difference between typical savings accounts and the guaranteed cash value of a life insurance policy (whether or not dividends are being added to it). A savings account or CD grows each year by a specified interest rate. The guaranteed cash value of a policy grows every year by a guaranteed dollar figure, not by an interest rate. This is important because if your account has no money in it, you should not care what the interest rate is. Money growing by a dollar figure is more meaningful.
Using the above calculators, we can interpolate the interest rate and see the guaranteed cash value has a gross rate of 4% and a net rate of about 2%. The dividend is added to the guaranteed amount for the total of 5.9% gross and 3.9% net as mentioned above.
What are common life insurance dividend options?
There are more than a dozen options, but these are the most-used:
Purchase “Paid-Up Additions.” PUAs represent additional “prepaid” insurance which builds cash value, earns dividends, grows tax-deferred, and increases the death benefit. This is a way of reinvesting into the policy and is usually the most popular option.
Cash / Check: A policyholder may request that the insurer send a check for the dividend amount. In this way, a policy can be used to create an annual income for the policy holder. Dividends are paid annually on the policy anniversary date.
Premium Reductions: A policyholder may request that the dividend be put towards future premiums to offset the cost. Annual dividends are applied towards the premium on the policy anniversary with this option. With established policies, dividends can eliminate premium payments completely.
Policy Loan Reductions: Dividends can help pay off a policy loan, reducing and even eliminating the need for cash-out-of-pocket.
Accumulate at Interest: The annual dividend may remain with the insurer to earn interest. This functions like a savings account. The interest earned is taxable to the policy owner annually, and money can be withdrawn without affecting the life insurance portion of the policy. Money accumulated becomes payable in addition to the face amount of the whole life policy as a death benefit.
What option do we recommend? In most cases, we recommend purchasing paid-up additions during the early years of your policy, then taking the dividend in cash during the later years or your policy (or policies). This maximizes both policy growth and (eventual) income drawn from the policy. If you have outstanding policy loans or if you are having cash flow issues, applying dividends towards loans or premium can make the most sense.
Learn more about life insurance dividend options in this episode of the Prosperity Podcast: “Life Insurance Dividend Options.”
Aren’t dividends just a return of overpaid premium?
They are technically classified as a return of premium, but they don’t necessarily work that way in the real world. Dividends paid over time can exceed the total amount of premium paid—sometimes significantly!
Therefore, it’s more accurate to say that dividends also represent the profits of the company. Dividends must be paid when companies are profitable—it’s one of the guarantees of whole life insurance. Because life insurance companies are managed very conservatively, there is almost always a modest profit.
Are life insurance dividends taxable?
Fortunately for whole life policy holders, the IRS does define dividends as a return of excess premium and therefore not taxable. However, be aware that if you take dividends in cash, you can owe taxes on dividends paid over and above the amount of premiums paid. Dividends re-invested as Paid-Up Additions are not taxed.
In contrast, cash dividends from public companies in the stock market are taxable.
Are life insurance dividends guaranteed? If not, how reliable are they?
We love this question, because the answer really creates confidence in the stability of the asset! No, whole life insurance dividends are not guaranteed.
However, mutual companies have paid dividends every year for more than 150 years, even throughout:
The Civil War
World War I
The Influenza Epidemic
The Great Depression
World War II
The Savings and Loan Crisis
The Dot Com crash
The Subprime Mortgage Crisis and Great Recession.
We think that’s a pretty good track record!
How can I earn life insurance dividends?
Start a whole life policy! We specialize in high cash value whole life insurance. This type of whole life builds cash value faster—earning larger dividends more quickly—than typical whole life insurance policies.
Contact me today to inquire about whole life insurance or convertible term. I can answer questions and provide quotes for policies in the form of illustrations. I also have a lot of experience with multi-generational life insurance (policies for children, grandchildren or parents).
UNCOMMON KNOWLEDGE
1. Whole Life Insurance: A Firm Financial Foundation | - […] For more on whole life insurance dividends, read “Understanding Life Insurance Dividends.” […]