What is a Dividend?
Dividends are an attractive component of whole life insurance policies that can provide the owner with an additional benefit as supplemental cash, a reduction in premium cost or an increase in the level of insurance coverage. Dividends are paid from a participating life insurance policy at the discretion of the board of directors and are not guaranteed. If the dividend is paid out as cash or a reduction in premium cost, the amount is considered a return of premium to the owner generally via a tax-free payment (up to the policy cost basis). If the dividend is reinvested in the policy, the value accrues tax free regardless of basis because it is not leaving the policy and is ultimately paid out income tax free if received as a death benefit. Policy dividends offer a lot of flexibility in the contract design and can be seen as a very attractive living benefit of a whole life policy due to its many uses.
How is the amount determined?
The size of the dividend is based on the operating performance results of the insurance company and can vary from year to year. The three core components to a policy’s dividends are:
The interest component is based on the difference between the company’s investment performance and the underlying guaranteed return on the cash value.
The mortality component is based on the difference between the actual claims and the guaranteed mortality rates underlying the cash value.
The final component of the dividend yield is determined by the operating expenses of the company. Depending on whether they were better or worse than what the company predicted, the expense return will be adjusted.
In 2012 Guardian Life Insurance Company approved a dividend payout of $795 million to individual life policy holders. Their dividend interest rate in this year, which is the investment component of the dividend, is 6.95%. In addition to the many ways the dividend is determined, the policy owner has the choice of using that dividend in different ways including:
How can it be used?
To reduce premiums
Dividends can be used to reduce or eliminate the annual premium cost. Once the policy dividend is equal to or larger than the annual premium, the owner may choose to stop paying premiums, if desired, at which point the policy may become self sustaining if the dividend is not reduced in future years.
To accumulate cash value and purchase single premium paid up additions
- Dividends can also be used to accumulate cash value within the policy on a tax deferred basis. The cash value, if any, can be accessed by the policy owner as a loan, subject to interest. Policy benefits are reduced by any outstanding loan and loan interest.
- Owners of a whole life policy can use the dividend to purchase additional death benefit and grow the cash value. In addition to the increased death benefit, the additional insurance is eligible for a dividend in subsequent years which can create a “dividend on a dividend” as long as the life insurance company continues to pay dividends.
The flexibility in how the dividend is paid out gives the policy owner leverage to use this product as a work horse for their financial situation throughout their lifetime. In addition to providing a death benefit, the policy dividend can offer the owner many benefits during their lifetime in the form of tax-deferred growth which ultimately can be paid out as a tax free death benefit and/or a lower cost for coverage. When considering whole life insurance consumers should favor mutually owned companies with a long dividend paying history for optimal results.
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