Dividend Paying Whole Life Insurance - Understanding What Sets it Apart

Published: 31st August 2010
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Whole Life Insurance, Universal Life, Variable Life, Term...with such an array of life insurance options available, it's easy to get lost in the confusion of what type of insurance is best for your life circumstances. Let's start by looking at the pros and cons of each type of life insurance policy.

Term Life Insurance

The biggest upside of term insurance is that you get life insurance at very inexpensive rates, at least in the beginning. Term life insurance is very cheap if you buy it young. And for the first years of your policy it will remain inexpensive. But as you age, and as your actuarial factors change, your premiums will increase--sometimes dramatically.

Most people either drop or convert their policy to permanent life insurance when this happens. In fact, a 1993 Penn State University study found that only 1% of all term life policies were ever paid out. In truth, term life insurance is really designed for one benefit--to provide a cash settlement for your family in the event of your death. This is why term life insurance is often referred to as renting life insurance versus owning. It can be a great buffer against unforeseen tragedies, and can, in the short term, provide necessary, inexpensive coverage. But as a long-term solution, it doesn't hold up.

Universal Life and Variable Universal Life

Universal life coverages combine the benefits of whole life insurance with some other flexible features. Like whole life policies, universal life allows you to accumulate cash on a tax-deferred basis. The cash you contribute will be invested by your insurance company and the profit from those investments are applied to the cash values of your policy tax-free. Investments are handled by the insurance company and are usually in bonds and money market funds. Investment profits can sometimes be applied toward premiums; the flipside of that being that in years of poor investment performance, your premiums could increase.

Variable Universal Life is universal life but it allows you to invest your cash values in the stock market. Essentially it puts you in control; you'll choose where your cash values are invested and all earnings within the policy are tax free. Because the stock market historically outperforms other investments, the potential for greater returns is significant.

But the stock market is volatile and cash values within this type of policy can fluctuate up or down depending on how the markets are performing. Many of these policies are sold using illustrated returns that are truly not indicative of what actually happens. In 2008, when markets were at all-time lows, sales of both universal life and variable universal life insurance dropped off considerably while people sought safer investments and either the guarantees of whole life or the cheap cost of term life insurance.

Additionally, the cost of these types of insurance is expensive and they do not offer the best protection or guarantees in the long term. The internal cost of the life insurance within these policies is often very steep and can offset the investment gains.

Whole Life Insurance and the Dividend-Paying Difference

Whole life insurance is also called permanent life insurance. You can also say it's, "What you see is what you get." That is, what's illustrated in the contract is guaranteed to happen. You pay a set premium for the duration of the policy and upon your death, your beneficiaries will receive the exact amount of your policy's stated death benefits. Like other cash accumulating life policies, the cash values within your whole life policy grow tax free.

But even whole life policies can vary in what they offer. Dividend-paying whole life insurance, for instance, provides the safety and security of whole life, while also providing performance-based dividends. A dividend paying whole life policy will pay dividends to its policyholders based on the company's annual profits. Like universal life policies, the company makes investments for policyholders, using the paid premiums. But there are some important differences.

With dividend paying whole life policies, investments are made in very safe financial instruments such as bonds, and they also diversify by industry, maturity & geography. This keeps costs and risks very low, and profits very steady.

As the cash values of a dividend paying whole life policy accumulate, policyholders are able, and even encouraged, to borrow money from the account for personal financing. This is often called self-banking or the Infinite Banking System. The Infinite Banking system's whole life policy is structured to maximize liquid cash values instead of concentrating on the death benefit. Which means you can enjoy your money now and still leave a financial legacy for your heirs.

What the Infinite Banking System does is make you the bank. You will save with your bank (premiums), you will borrow from your bank (tax free), and when you pay interest on your personal loans, you'll be paying yourself. So instead of paying out interest to a bank or other financial institution, you make money on yourself. The dividend-paying whole life insurance policy provides the financial structure to make this concept possible.

There are numerous other benefits associated with dividend-paying whole life and the Infinite Banking Concept. Cash values within your policy accumulate free of tax. Distributions from your cash value via personal loans are also tax free. Withdrawals from the policy can be made tax-free up to your basis, or the amount you have contributed to the policy. Additionally, the death benefit proceeds pass to your heirs income tax-free.

The Company You Keep...

With these types of insurance policies, it is wisest to choose a mutual company as opposed to a company traded on the stock market. In a mutual company, the policyholders are the owners. So, the policyholders will be the first in line to benefit from strong company performance.

A stock company, on the other hand, is owned by its stockholders. It will be run by a board of directors who are trying to get the best return on investment for their stockholders, not their policy owners. This can make a huge difference in investment profits and dividend earnings.

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