John "Hutch" Hutchinson | Founder, Banking Truths
In the final article of our three-part series, the usage of dividends in whole life insurance policies is further explained.
Whole Life Dividend Usage In Accumulation Years
Paid-Up Additions (PUAs) are the best dividend option if your goal is to maximize the performance of both your whole life’s cash value and death benefit. Choosing the paid-up additions dividend options creates the most long-term compounding of your cash value, death benefit, and therefore, future dividend payouts.
Increase your cash value by 90%-95%
Buy 1.5x – 4.5x of paid-up death benefit depending on age/rating
Increase your whole life policy’s cut of future dividend pools
Lift your policy’s guaranteed growth curve since your cash value must equal your death benefit by age 121
There may be times where it seems like other dividend options may seem more appropriate, but not if these are only temporary needs and your primary goal is to maximize your whole life policy’s compounding. For instance, if you are experiencing a temporary cash flow crunch where you cannot pay your whole life base premium on time, you could elect to have your dividends to reduce your premium. However, you would then lose all the future growth those dividends could have compounded into as paid-up additions. Another solution would be to have your whole life policy borrow against its own equity to pay the base premium via an Automatic Premium Loan (APL). That way, your dividends could continue maximizing compounding through purchased paid-up additions.
Another temporary issue would be if you already had a loan outstanding. It may be tempting to switch your dividend option to reduce the loan. Again, doing so would cause you to miss out on all the future compounding potential of those dividends if they had purchased paid-up additions. A temporary solution would be to have your dividends buy more PUAs and keep floating the policy loan since your full cash value continues earning interest and dividends (even the amount you borrowed).
If either temporary situation becomes a permanent problem where you can no longer pay either premiums or a policy loan, you can always do an RPU, whole life’s ultimate bailout provision. RPU stands for the Reduced Paid-Up non-forfeiture option available by law with any whole life policy from any mutual company. It was created to offer consumers a smaller but fully paid-up whole life policy if they can’t afford to keep paying for whatever reason. Since you are prepared for the worst with this ultimate legal bailout provision, we believe it’s often better to hope for the best. Having your policy dividends buy paid-up additions as early and often as possible will build up substantial guaranteed cash value as well as contractually paid-up death benefit, both of which increase your share of future dividend payouts from your mutual insurance company.
Whole Life Dividend Usage In Preservation Years
Once you are ready to retire, you may be ready to stop funding your policy and no longer want to pay back loans. For this stage, we recommend switching future dividends to be paid in cash for a steadily increasing income stream. Taking dividends in cash does not decrease your death benefit, yet your cash value still climbs each and every year on a guaranteed basis. If you want a more aggressive income stream, you can also surrender PUAs purchased from prior dividends. This will obviously reduce your death benefit but may provide a much higher ongoing retirement income stream.
Once you have taken out more cash than you have put into your policy, you can always take a policy loan against what cash value is left in your policy to avoid taxation. So long as some minuscule amount of death benefit is in-force at the time of your passing, there is legally no tax imposed on any prior lifetime withdrawals, loans, or the death benefit itself.
Whole Life Dividends If You Get Sick in Retirement
Keep in mind the general advice given above assumes that preserving death benefits is not your priority. However, if you find yourself in bad health, you can change your dividend option back to purchasing PUAs to maximize the amount of tax-free death benefit left behind for heirs. Although whole life dividends can be a great source of tax-free income during your lifetime, a whole life policy’s death benefit will always be greater than the amount of cash value you can spend while you’re alive.
Final Word on Whole Life Dividends
There are certainly an awful lot of myths, misunderstandings, and misinformation when it comes to whole life dividends. Dividends will matter when it comes to the overall performance of your whole life policy. But arguably more important are paid-up additions, an option once dividends are declared. Also, clients will often judge a mutual insurance company’s dividend rate even though each company’s dividend formula and crediting methodology differ from each other.
The best thing you can do is work with an agent who is willing to educate you on the top mutual companies and compare their leanest possible designs for you. That way, you can not only see how robust the dividends are, but also see the efficiency of the guaranteed growth and PUA ratios to provide the best overall performance.
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