Whole life insurance offers lifetime protection and accumulates a cash value. However, some of whole life policies go even further. They also distribute dividends.
These are known as participating whole life insurance policies or dividend paying whole life insurance policies.
Continue reading to find out more about dividend paying whole life insurance and whether it is right for you.
What is Whole Life Insurance?
The most common type of permanent life insurance is whole life insurance. It guarantees that your family will receive the insurance benefit regardless of when you pass away. In contrast, term life insurance has an expiration date and provides a payout only if you die during a certain term. Whole life insurance has no expiration date; the coverage ends when you pass away.
Whole life insurance policies also feature a cash value investment component. A portion of your premium is used to build the cash value, while the remaining is used to cover insurance and administrative costs. The cash value of your policy grows tax-free over time at a fixed rate.
You can access the cash value of your policy at any moment while you are still alive. Any unused cash value at the time of your death is usually returned to the insurer. In most cases, the beneficiary receives the death benefit and not the monetary value. Whole life insurance is also known as cash value life insurance at times.
Why buy Whole Life Insurance?
Whole life insurance is generally 10 to 15 times more expensive than term life insurance. Despite the higher price, it may be a better option for some.
Consider whole life insurance if you have long-term or permanent demands. For example, if you have a lifelong dependent or want to use life insurance to preserve your assets, you'd want a policy that ensures your beneficiary will receive the death benefit one day. Whole life insurance provides this security and, as such, may be appropriate for you.
Purchasing whole life insurance may also make sense for someone who want to cover burial expenses and end-of-life medical expenses. You may also find it appealing if you are a high-net-worth individual searching for an insurance coverage that serves as an investment instrument in addition to providing lifetime protection.
Some whole life insurance policies provide dividends as well. Life insurance dividends are a benefit granted to policyholders when insurance companies outperform their peers. You are not guaranteed to receive dividends every year, and the amount may vary from year to year. Participating life insurance policies are policies that pay dividends.
What are Guarantees?
Whole life insurance provides three guarantees:
- a guaranteed level premium (fixed monthly price)
- a death benefit (life insurance payout), and
- guaranteed cash value growth
A guaranteed level premium ensures that your premium rate will remain constant throughout.
A guaranteed death benefit ensures that your family will get the full death benefit tax-free if you die.
Guaranteed cash value growth means that the cash value of your policy will rise at a predetermined pace each year until it reaches the policy amount at a specific age, usually age 100.
What are Dividends?
A life insurance dividend is a portion of the premiums paid into the policy that is returned. Remember that not all life insurance policies pay dividends. Only whole life insurance policies that participate pay dividends. Dividends are not guaranteed; you might not get them every year.
Participating life insurance policies offer dividends and allow you to share in the insurer's profits as a policyholder. A mutual insurance firm can only sell participating life insurance plans, however these policies can also be issued by other companies. Policyholders rather than shareholders own a mutual insurance firm.
Insurance dividends are not typically taxed as income to you. Any interest you earn on your dividend payments, on the other hand, is taxable.
How Does Dividend Paying Whole Life Insurance Work?
Dividend paying whole life insurance works in the same way as traditional whole life insurance does. The main difference is that it pays insurance dividends.
Whole life insurance is a type of long-term insurance. The plan remains in effect as long as your premiums are paid on time. When this occurs, your beneficiaries will get a predetermined death benefit. Insurance payouts are often tax-free.
As a policyholder, you pay fixed level premiums throughout your life. The premium payments are divided into two portions:
- cost of insuring you and administrative fees
- contributions to your policy’s cash value.
There are several ways to obtain the policy's cash value. You can, for example, withdraw it all or partially, or borrow against it. You do not have to repay the loan because it is your money. However, the sum will be taken from the face value of your policy following your death, meaning your beneficiaries would get less money than planned.
Insurance dividends are a feature of participating life insurance policies. These payments are a portion of the insurance carrier's profits that are distributed to policyholders. Dividends are given out once a year, although they are not guaranteed. If the insurance company performs well in a given year, it will pay an annual dividend. If it does not, you will almost certainly not receive a dividend. When dividends are given, policyholders can choose how to spend them.
How Can You Spend Your Dividends?
Depending on your insurance contract, you will likely have different options for spending the dividend payments. The most common options offered by life insurance companies include:
- Buy paid-up additional insurance
You can also use the annual dividends to buy additional insurance with a single premium payment. The top-up death benefit purchased thus is called paid-up additional insurance, “additional” because you are buying extra coverage and “paid-up” because no future premiums are payable for this additional coverage. So, while your death benefit increases, your premium rate remains the same.
When you use your dividend payments to buy additional coverage, you do not have to undergo a medical exam nor answer invasive health-related questions. The insurer cannot factor in your health to determine how much extra coverage you can buy.
How much additional coverage you purchase depends on two things:
- the dividend amount (the higher the dividend amount, the more death benefit you can buy)
- your age (life insurance rates increase with age, so the younger you are, the more coverage your will be able to buy).
Most policyholders choose to buy additional coverage with dividend payments, and understandably so. Once the policy’s face value increases, the insurance carrier cannot reduce it. Over time, the initial death benefit can double or even triple. Your cash value will also increase substantially.
- Premium deductions
You can use the annual dividend to reduce your premium payments. Let us assume you pay $865 annually to keep your participating whole life insurance policy in force. Since this year you received a dividend of $265, you will have to pay only $865 - $265 = $600.
This option is not available if you pay your premiums monthly. You can use this option only if you pay the premiums quarterly, semi-annually, or annually. Because insurance dividends are paid on the policy anniversary, only your anniversary premium payment will be lowered by the dividend amount.
In case the dividend payment is more than the anniversary premium amount, you might use the remainder to buy paid-up additional insurance or pay off part of the policy loan. Alternatively, you can collect the excess dividend in cash or leave it with the insurer to accumulate interest. By default, insurers usually use the excess dividend to buy paid-up additional insurance if the policy owner has left no instructions.
If you wish, the insurance carrier will send you a check for the dividend amount.
- Pay off a policy loan
You may use the dividend amount to pay off all or part of a policy loan.
- Savings account
You can also choose to keep the insurance dividend with the insurer and earn interest on the invested amount. The insurance company will put the dividend in a savings account and reinvest the money. You will earn pre-determined interest and are free to withdraw the funds at any time you want. Keep in mind while dividends are generally not taxable, you will receive a tax bill for any interest you earn on the principal amount.
Types of Dividends typically available with participating whole life policies:
- Paid Up Additions – Dividends are used for buying additional whole life insurance, which in turn increases the death benefit. The paid up whole life insurance earns dividends and also accumulates cash value at the same rate as the base policy.
- Enhanced Protection – Dividends go toward purchasing one-year term life insurance.
- On Deposit/Cash Accumulation – The insurance company puts dividends in a savings account and the money grows at a competitive rate.
- Paid in Cash – Dividends are paid directly to the policyholder.
- Premium Reduction – Dividends are used for paying for the insurance premium in full or in part. If the insurance dividend exceeds the premium amount, the excess may be paid in cash to the policyholder or used for purchasing additional paid-up whole life insurance.
Is a Dividend Paying Whole Life Insurance Policy Right for You?
Dividend paying whole life insurance, like any other insurance product, has advantages and disadvantages. Its suitability is mostly determined by your financial objectives. However, understanding the benefits and drawbacks of this one-of-a-kind life insurance plan can help you make an informed selection.
Pros of dividend paying whole life insurance:
- Create an extra stream of income
Participating whole life insurance policies can help create an additional stream of income. These plans pay annual dividends whenever the insurance company does well. Although insurance dividends are not guaranteed, many Canadian insurance companies have been paying them consistently.
- Increase the death benefit
Assume you purchase a $100,000 entire life insurance policy. However, after a few years, you realize your family requires more protection. One possibility is to buy another permanent life insurance policy. However, if your health isn't what it used to be, the new coverage would most certainly cost you a lot of money. If you own a participating policy, you can also utilize the annual dividends to buy more insurance. You will most likely get more bang for your buck because no additional underwriting is required.
- Level premiums
With participating whole life insurance, you can increase your death benefit while paying the same premium as before. A regular whole life insurance plan also offers level premiums, but it does not allow you to purchase additional coverage.
- Accumulates cash value
Dividend paying whole life insurance policies accumulate cash value, like regular whole life plans. However, with these policies, the potential to accumulate wealth is greater, since you have the option of buying additional paid-up coverage.
Cons of dividend paying whole life insurance:
- Higher premiums
Compared to a non-participating policy, a dividend paying whole life plan costs more.
- Dividends are not guaranteed
Dividends are not guaranteed, so you cannot plan the purchase of additional paid-up coverage in advance.
What are the different types of whole life insurance?
Apart from participating whole life insurance, there are several other types of whole life insurance plans.
- Life Pay Whole Life Insurance
This is the most common type of whole life insurance policy. It offers guaranteed level premiums and a level death benefit — meaning both your premiums and death benefit will not change as long as the plan is in force. Life pay whole life insurance accumulates cash value at a fixed rate.
- Limited Pay Whole Life Insurance
Limited pay whole life insurance offer lifelong coverage and cash value accumulation as long as you live. But the premiums are payable only for a limited number of years, such as 10 years, or until you reach a certain age. Because a limited pay whole life insurance plan has a shorter payment period, the premiums are higher than a comparable life-pay policy.
- Single-Premium Whole Life Insurance
The single-premium whole life insurance is a type of life insurance product that you can fund with one lump sum payment. Since no future premium payments are required, these plans cost a lot of money upfront. The upside, however, is that your whole life insurance plan will have an immediate cash value. In contrast, other whole life insurance plans take a few years to build up any significant cash value.
- Graded Premium Whole life Insurance
Graded premium whole life insurance promises a level death benefit, but not level premiums throughout your life. During the initial few years, the premiums are lower, and then they increase gradually, before leveling off and remaining the same for the rest of your life.
- Guaranteed Issue Whole Life Insurance
Whole life insurance with guaranteed issue assures level premiums and a flat death benefit. However, no medical underwriting is involved. To demonstrate insurability, you will not be required to undergo a medical examination or answer health-related questions. As long as you are within a particular age range, approval is practically certain.
Guaranteed issue life insurance is more expensive than fully underwritten whole life insurance, but it can help you gain some level of coverage if you are unable to obtain a conventional policy due to bad health. Guaranteed issue insurance feature lower payouts, typically not exceeding $50,000. They may potentially accumulate cash value, but the potential for wealth accumulation is significantly lower because the policy amount is so little.
- Non-Participating Whole Life Insurance
These whole life insurance plans do not pay policy dividends. Apart from that, they work the same way as participating policies. That means your non-participating policy will accumulate cash value at a fixed rate and your premium rate and death benefit will remain the same throughout.
Participating whole life insurance policies can generate dividends. A dividend is a return of part of the premiums paid by you. Although dividends are not guaranteed, some Canadian life insurance companies have an excellent record of paying them consistently for the past 100 years. If you are interested in buying a dividend paying whole life insurance plan, Dundas Life can help you get the best quotes.
Frequently Asked Questions
What kinds of life insurance pay dividends?
Whole life insurance is the only life insurance product that pays annual dividends. But not all whole life insurance plans pay dividends. Rather, only participating whole life policies do. Other types of life insurance products, including universal life and term life do not pay dividends.
For how long do you pay for a whole life policy?
Your policy document will list the payment period, which can be different for different policies. Some whole life insurance policies give you the option to pay premiums for life (age 100). Some others let you pay the entire policy in a shorter period, like 10 or 20 years. Yet some others let you pay the policy in full with a single premium payment.
Who should have whole life insurance?
Whole life insurance is an option for everyone who wants to ensure that their loved ones will receive the death benefit one day. Whole life insurance may be appropriate if you want to leave an inheritance, use life insurance for estate planning, contribute money to a charity after death, or pay for your burial in advance. It may also be appropriate for those who desire more from their life insurance coverage than just the death payout. If you have a high net worth and have exhausted all of your typical investment alternatives, you may profit from purchasing a whole life insurance.
Do all whole life policies provide dividends?
No, all whole life insurance plans do not pay dividends. Only participating whole life plans pay annual dividends.
Is it better to buy a dividend-paying whole life insurance policy when you are younger?
Yes, it is. Buying life insurance when you are young and healthy allows you to lock in low premium rates for your entire life. Also, purchasing a participating whole life insurance plan early in life means you will have more years to collect dividend payments and accumulate cash value.
What is the difference between whole life insurance and term life insurance?
Both these life insurance products aim to provide financial assistance to your loved ones in the event of your demise, but they are very different from each other.
- Whole life insurance offers lifetime protection, as long as you pay premiums. By contrast, term life insurance remains in effect for a specific period, like 10, 20, or 30 years, or until a certain age.
- Whole life insurance builds cash value which you can use while you are still alive, whereas term life does not include the cash-value component.
- Whole life insurance plans may earn dividends. Term life plans, however, do not pay dividends.
- Because whole life insurance provides lifelong coverage and builds cash value, they are significantly more expensive than term life. In general, expect to pay 10 to 15 times more for a whole life plan compared to a similar term life policy.
Can you withdraw dividends from life insurance?
Yes, you can receive insurance dividends in the form of cash. Life insurance companies give several options for accessing the dividend payments, with one of the options being receiving them in cash. Other options include purchasing additional paid-up insurance, paying all or part of the anniversary premium bill, and keeping the money with the insurer to earn interest on the amount.
Do you pay taxes on life insurance dividends?
Life insurance dividends are tax-free. This is one of the features that make dividend paying whole life insurance attractive, especially for tax planning purposes during retirement. Keep in mind that while dividends are not counted as taxable income, any interest you earn on them is taxable.