Policy “dividends” are a unique feature of Participating Whole Life insurance unlike any other product. The word “dividend” in this context is a confusing term since it does not perform like a stock dividend. Policy Dividends are technically a return of overpayment of premiums. All policy owners‘ premiums go into a segregated account to form the reserves, and are invested and used to pay out death benefit claims. While this money is held in the segregated account, the money is invested to help grow some additional safe returns. Keep in mind that all investment risk is borne by the insurance company as any investment losses do not get passed back to the policy owner, like normal investment accounts or Universal Life. Any excess returns or cash value on hand at the end of a year, based on what the insurance company had projected at the beginning of that year, can be subject to payment as policy dividends.
Most companies have five dividend options to choose from, and you can change them as often as you like: 1) Paid-Up Additions, 2) Enhanced Coverage, 3) Premium Reduction also known as Premium Offset, 4) Cash Accumulation, and 5) Cash Withdrawal Account (meaning they send you a cheque every year). Each option has its advantages, but for the concepts featured in this book, the Paid-Up Additions is the one that we prefer.
With “Paid-Up Additions”, the dividends purchase a miniature policy (that gets added to the base policy) that has its own guaranteed cash value, earns its own dividends, and has its own guaranteed amount of death benefit. And all these additions will be added annually, adding to your base policy values. No further premiums are required for these permanent additions and they help drive growth of your policy over time.
While the dividend amount may fluctuate and is not guaranteed, most companies have never missed paying some sort of a dividend payment over the last century. This period dates back to the confederation of Canada, the US Civil War, the first and second World Wars, the Great Depression, and even more recently the Great Recession of 2008. Once policy dividends have been paid, they become guaranteed and cannot drop in value. They are not taxable as long as they are left in the policy and they are added into your policy death benefit and policy cash value.
It is important to note that dividends that are paid out in cash not only will most likely result in taxes payable, but more importantly, they will reduce the future growth potential of the policy. This is part of why we do not recommend this type of policy dividend option if you are looking to make full use of all of the features in this book.
Note: The “Enhanced Coverage” dividend option is an option that could be considered in very unique situation. In short, “enhanced coverage” means buying a certain amount of Whole Life insurance and using a one-year Term insurance rider or option (this amount renews automatically each year for one year only) which will provide additional coverage up to the full death benefit amount needed. This can be attractive if buying the entire need of insurance need as a Whole Life insurance coverage is too expensive to undertake initially. Using the “Enhanced Coverage” option makes this easier. Over time, as your policy dividends, in part, pay for the additional one-year Term insurance that will provide the additional coverage up to the full amount of death benefit amount required. This amount renews automatically each year but as the whole life portion of your policy grows each year, the amount of one-year term insurance needed each year eventually falls to zero. Over time, you will own 100% whole life insurance and your dividends will purchase “Paid-up Additions” for their full amount going forward.