Understanding Insurance Dividends – Episode 063

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[00:00] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, best-selling author, Kim D.H. Butler and No BS Money Guy, Todd Strobel. Hey everybody, welcome to another edition of the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. Once again, my co-host and best-selling financial author, Kim Butler, is here with us. Welcome, Kim. Todd, glad to be here. Thank you. Today, we’re going to be talking about dividends and the options that you have for dividends specifically inside a life insurance policy. And this is once again, prompted by one of our listeners wanting more information. So again, we would encourage anybody who has financial questions, send them in and

[00:51] we’ll make a podcast out of it. So take it away, Kim. Wonderful. This is something that was good for me to dig back into because so often in the life insurance arena, we just default our dividend election to paid-up additions. And our listeners will know that inside our Live Your Life Insurance book, which by the way, we have a second version coming out any day now, expanded as well as cleaned up a little bit. Inside the Live Your Life Insurance book, we differentiate between manual paid-up additions and automatic paid-up additions. And automatic paid-up additions are what the dividend creates. So to back up a little bit, the insurance companies at the end of the year, in fact literally here any day now, will declare their dividends for the next year.

[01:41] And they actually declare them in the form of a dollar figure. But we tend to work that backwards and put them in the form of an interest rate so that we can understand them. But there is a misunderstanding out there in the world that dividends are an interest rate when in actuality they’re not. They’re a dollar figure. So what do you do with this money? Well, the most logical one is to let it automatically buy paid-up additions, which is a funny term for little tiny policies that are paid up that have both cash value and death benefit and the ability to get the dividend the following year. And so that’s what most people do with their dividends. They just elect the option to have their dividend purchase paid-up additions, which

[02:28] works great all during your funding year. So when you buy a policy, typically the first 10 to 30, 40, 50 years, you’re going to have your dividend buy paid-up additions on an automatic basis. And that’s separate from any extra manual paid-up additions you might add yourself. So dividend, paid-up additions, one option. There’s a whole bunch of others. Yeah, please. Just so that we’re fully on board with this. Do all insurance companies pay dividends and do all types of life insurance policies pay dividends? Oh, great question. So no, all insurance companies do not pay dividends. Typically mutual companies pay them versus stock companies, which are publicly owned that may or may not pay them. But mutual companies have always paid them for every single year that I’ve ever researched.

[03:25] So 150, 60, 70 years of history. Now they’re not guaranteed that they’re going to be paying them in the future, but typically mutual companies pay them, stock companies typically don’t. You may have some stock companies that are. And then in terms of the type of policy, there are mostly whole life insurance policies that receive dividends. Again, from mutual companies, there are typically no term policies. There might be a few. And typically universal life policies do not receive dividends because they do receive interest. And as I’ve indicated, that’s different. So you’re mostly looking at a whole life insurance policy. It’s called a participating policy. And that’s what we mean as they get the dividends, which represent 100% of the profits

[04:15] from the insurance company after expenses and reserves. So the dividends and the whole life policy are the best way to get access to the profit of a mutual company. Superb. Thanks for clarifying that. Great questions. So what else can you do with your dividends? Well, one of the things that you can do is actually get them in cash. And so this is a strategy for down the road. You might have cash payments come to you, maybe to educate a child. But more typically, you’re going to just save that until later in your era of financial independence where you’re not really earning money anymore. So cash payment is an option. You can also have your dividends reduced premium. This is a very common strategy for a lot of life insurance agents to recommend to

[05:04] their clients. We do not. We believe that the best way to take advantage of life insurance is to put as much in it as possible, not as little in it as possible. And so I’ll often see a client with a whole life policy that has its dividends set to reduce premium. And I’ll ask them to go back to their life insurance company and ask for a change of dividend, which can easily be done, no cost, so that that dividend is being essentially reinvested, which is the pay to petition idea. So just I think I’m understanding this and you’re saying that even if you have an existing policy, you can change your dividend options. Absolutely. The policy is in effect. Absolutely. Anytime, no charge. Super. Yes.

[05:55] Very helpful thing. So another dividend option is to actually let the dividend accumulate at interest. And I have no idea why anybody would do this, but it is an option. It would be taxable, which just doesn’t make sense to me. And so it’s there. I’m not really sure why. I don’t see that as an advantage at all, but it is an option. And then there’s a variety of term writers. So whole life policy with a term writer and using the dividend to buy the term writer. So you can get them in excess of cash value. You can get them to grow the death benefit faster. If you need more death benefit, then you can handle just with your whole life policy. There’s other additional ways to increase the coverage.

[06:49] There’s special term policies that reduce over time. There’s term policies that rise over time. Whole bunch of options with, let’s just call them one year term writers, and sometimes it’s 10 or 20 year term writers, that use the dividend to pay for the term insurance. And there is some company that allows for that to be used to decrease the possibility of your whole life policy becoming a modified endowment contract. So let’s back up a minute on that. If you put too much money in your cash value policy, it essentially is no longer insurance. And it’s because the death benefit is too low for the cash value that’s in there. It’s called a modified endowment contract, and it’s not the most effective tax law.

[07:36] It’s not the end of the world if that happens, but it’s generally something that we try to avoid. So if you have a policy that’s at risk for that, you can actually use your dividend to ride a term insurance environment where it rises, and that way, as the cash value rises, the death benefit rises, and you no longer have a modified endowment contract. So a helpful strategy. And my understanding is once a modified endowment contract, always a modified endowment contract? Is that correct? That is correct, yes. You cannot fix them. Sure, the insurance companies do let people know that they have 30 days if a policy is at risk of becoming a modified endowment contract. So it’s usually easy to fix, and again, if it doesn’t get caught, it’s not the end

[08:26] of the world. It just causes any loans against cash value to be taxable, whereas loans against cash value on a typical life insurance policy are not taxable. And if we were to say, you know, which of these are the most used, what would you say? Well, definitely the paid up additions writer, and then there is actually one more that I want to mention, which is used quite a bit as well, and that’s to repay your loans. So as a general rule, we want you to repay your loans. You borrowed the money. You used it for something. Let’s get that money paid back so that it’s accessible again. But if somebody gets into a situation where they’re just stuck, you can absolutely use your dividends, again, which are dollar figures that come in every single year to repay loans.

[09:14] So that can be an effective use of dividends. And again, as you indicated, these are all elections that can be changed at any time all along the way, back and forth, up and down, as you progress throughout your life. And again, there are lots of information about this in our live your life insurance book. And a new version of that is coming out very shortly. We’ll have it both on Amazon and as an audio and we’ll make it available to our podcast listeners. Super. Have we missed any? I don’t think so. And again, you would say that the paid up additions writer, number one, and then I was thinking about that term writer as well, maybe in a mortgage type situation. Yes. So you mean the term writer in order to pay off a mortgage at some point?

[10:05] No, I mean, in using converting part of your dividends to buy term insurance when you increase your indebtedness. Yes, absolutely. That is a strategy. And if you’re going to increase the policy after you’ve already started it, then there would be some underwriting that would have to have gone through it and probably a new exam and some paperwork. Most often, the term writers are added at the beginning of the policy where somebody has, say, a hundred thousand dollar whole life policy, but they really want to have, say, two hundred and fifty thousand of coverage and they just don’t have the money for it. Well, they can either buy a separate hundred and fifty thousand dollar term policy or they can use their dividends from the whole life policy to buy a

[10:52] hundred and fifty thousand dollar term writer and accomplish the same thing. Super. We’ve got a question that just came in. That’s a good one. And it’s if I don’t know what the heck I have or what the heck I can do with my policy, can I call you? Absolutely. So the first thing that you should do is call your insurance company and ask for an in force illustration. The word is in force I N F as in Frank O R C E and then absolutely email that to me and I will be able to explain it to you in plain English and I’m happy to help anybody with that. If you’ll email me an in force illustration, I’ll tell you whether it’s universal life or whole life. I can even tell you the internal rate of return and give you some clarity

[11:38] around any dividend options. If there are those available strategies about how to save the policy, if it’s starting to have problems, more than happy to help. That’s a very quick thing for me to look at as long as I have that in force illustration. Super. Well, that’s a great offer. And I would encourage people, especially if you’re at a point where you’re having problems making the premiums, don’t let a policy lapse without talking to an agent like Kim, who can really show you some things that might be able to accomplish a lot saving you money monthly and keeping your policy in force at the same time. Correct. Absolutely. That is correct. Super. Well, this is No BS Money Guy, Todd Strobel for the Prosperity

[12:19] Podcast. And Kim, I really got to thank you for this one. I think our listeners are going to get a lot out of this and it’s very generous of you to offer to help them. Thank you so much. Absolutely. Everybody enjoy. Take care, everybody. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.