The Truth About Whole Life Insurance Dividends

When you buy a participating whole life insurance policy, the insurance company might pay you a dividend at the end of the year. It sounds like a great perk - who doesn't like getting a check? But before you factor these dividends into your retirement plan, you need to understand exactly what they are and how they work.

A whole life insurance dividend is essentially a return of your own money. When an insurance company prices a whole life policy, they make conservative estimates about how many people will die, how much it will cost to run the company, and how much they'll earn on their investments. They charge you a premium based on those conservative estimates.

If fewer people die than expected, or if the company's investments perform better than projected, they have a surplus. If you own a participating policy, they return a portion of that surplus to you as a dividend.

Are Dividends Guaranteed?

No. This is one of the most important things to understand. The insurance agent selling you the policy might show you an illustration with impressive dividend projections, but those are just projections. The company's board of directors decides each year whether to pay a dividend and how much it will be. While some major mutual companies have paid dividends consistently for over a century, the amount can and does fluctuate based on economic conditions.

How Can You Use Dividends?

If your policy pays a dividend, you typically have a few options for what to do with it:

• Take the cash: You can receive a check.
• Reduce your premium: You can apply the dividend to your next premium payment, lowering your out-of-pocket cost.
• Accumulate at interest: You can leave the money with the insurance company to earn interest (which is taxable).
• Buy paid-up additions: You can use the dividend to buy a tiny bit more fully paid-up whole life insurance, which increases your death benefit and your cash value.

Here's where we need to have some straight talk. A lot of folks get sold on whole life insurance because of the promise of these dividends. They're told it's a great way to build wealth. But let's look at the reality.

Insurance is a cost, not an investment. When you buy whole life insurance, you're buying a product that combines a death benefit with a savings component (the cash value). The premiums are significantly higher than what you'd pay for a term life policy with the same death benefit.

The Real Comparison isn't between whole life and nothing. It's between whole life and buying term insurance while investing the difference yourself. Every permanent policy is essentially a term policy welded to an investment you don't control and can't leave without surrendering the policy.

Let's look at the numbers. The internal rate of return on the cash value of a whole life policy, even factoring in dividends, is typically quite low - often in the 3% to 5% range over the long haul. And that's only if you hold the policy for decades. In the early years, the return is negative because your premiums are going toward the agent's commission and the cost of insurance.

Protect what you've earned. Cover your risk with the minimum necessary - which is usually term life insurance - and build your wealth in vehicles you control, like an IRA, a 401(k), or real estate. Your dollars are votes, and you shouldn't lock them up in a complex insurance product just to chase a non-guaranteed dividend.

If you're looking for a way to protect your family's financial future, we can walk you through every option. We'll give you straight answers, no surprises.