If you bumped into this article, chances are that you need answers to few questions which might be bothering you when it comes to managing and investing your money in the right financial products. Very important concept which relates to our topic of discussion is:
Should Life Insurance Be Used As An Investment Tool?
If you check the link above you will get your answer. In personal finance, many names are given to the same concept. Dividend paying whole life insurance policies are also known as return of premium life insurance products. If you are looking to beat the inflation rate and also expecting good returns out of your money then stop right here. Do not even think about it! Insurance and investments are two different aspects designed to cater specific financial needs of an individual. Life insurance policies are bought to secure the financial future of your dependents in case something happens to you which results in loss of income. In other words, you are funding to cover your death. When looking at traditional areas of fixed income opportunities, generally we always think of stocks and bonds. This article will explore the opportunity of thinking dividend paying whole life insurance policies as fixed income opportunities. If you are thinking on those lines then read further:
To understand dividend paying life insurance principle, we need to first understand the concept of INFINITE BANKING. In simple terms it means that you create your own private banking system. You save money over the years which keep on accumulating along with interest and later on use the same money to take care of major financial expenses in your life. Alternatively, we can also say that the focus shifts towards living benefits (cash value component) from death benefit.
Now before we even get into the nitty gritty of this, let me tell you that it may work for some and may not be required for others. Meaning, it does not work in every situation.
Dividend paying whole life insurance policies allows you to utilize infinite banking concept in a manner wherein the policy builds up cash value and replaces the death benefit (insurance) over time. More importantly, this happens on a guaranteed basis. Hence, such policies at times are called supercharged savings account. You can expect somewhere around 4.5% to 6.5% tax deferred returns. Please bear in mind that returns are not guaranteed.
When thinking about purchasing dividend paying whole life insurance policies, first and foremost do not get confused between the dividends returned in whole life policies with the returns you get from the stock market. Also whole life insurance is different from universal life insurance. As I mentioned, in the world of life insurance, dividend means return of premium. Your own premium is returned back to you by the life insurance company. Now when I discussed return of premium policies in an earlier article, I stressed on the fact that to make return of premium policies work for you, you need to start early. It is best suited for people who can pay the premium for a stretched period of time. I am talking about 15 to 20 years. This fact still hold true. Having said that, when we think of investing our money, knowingly or unknowingly we want certain criteria to be fulfilled. Our ROI is derived from certain question mentioned below:
1) When it comes to our money we need security. In other words, we seek guaranteed returns, right?
2) There is no harm in earning dividend over and above the guaranteed returns.
3) In case of emergency, you should be able to access your funds, and
4) What if, along with returns you can get death benefit advantage?
I know, all this sounds too cheesy but this is how dividend paying whole life insurance policy is sold to individuals who lack financial knowledge.
A whole life insurance is 15 to 20 times costlier than term life insurance and as the name suggest you pay the premium for the whole life span.
CASE STUDY ON DIVEDEND PAYING WHOLE LIFE INSURANCE POLICY
Important Aspects Of Dividend Paying Whole Life Insurance
- If you do not have the acumen or understanding of complex investment tools, you are young and earning individual or a conservative investor with no risk appetite and is responsible enough in understanding the concept of saving for the future then dividend paying whole life insurance could be a good option.
- Although life insurance products are sold due to death benefit. Such whole life products are good for individuals who are single with no dependents.
- Any life insurance policy which pays dividends is also known as participating policy. Hence the term dividend paying is associated with participating.
- Some of the advantages of such insurance plans are:
1) Guaranteed death benefit
2) Tax free growth and dividend payout
3) The cash value component is always accessible
4) Growth is guaranteed. We can call it high potential with low risk type of investment option
- Including a dividend paying insurance policy into your portfolio is the first step towards diversified investment plan. The key is to start early.
- The key is hold onto the insurance plan for the whole life. Meaning the cash value component equals the premium which you have paid over the years. Sadly, as per historical data less than 10% people are able to do it.
- The dividends can be paid in 4 ways. Either cash, savings, in the form of premium or you can even buy more insurance if you wish.
- Dividends are paid each year on the anniversary of your policy (commencement date). Dividends are calculated as a certain percentage of accumulated cash value. Example: If your current cash value is $75,000 and dividend yield is 4% then your payout will be $3,000. Moreover if out of that $75,000 cash value you request a policy loan amounting to $30,000 then the dividend payout is calculated on the remaining amount. In this case it is ($75,000 – $30,000) = $45,000. So your dividend payout will be $1,575
Tax Implication On Dividend Paying Life Insurance Policies
Now let us look at the tax implications in detail. If the dividend payout is used to pay for the policy premiums, or you decide to add it to your cash value component then they are not taxable as the payout is not directly made to you.
If the dividend payout is less than the annual premium amount paid by you then also the dividend payout is not taxable and it is referred as “Return Of Premium”.
If the dividend payout is greater than your annual premium then the difference is taxable.
To conclude, if you are looking to add a dividend paying whole life insurance policy a part of your investment portfolio, then the first thing you should check is the financial stability of the life insurance company as the dividend payout largely depends on how strong is the organization.