Lies Told About Whole Life Insurance Dividends

When considering whole life insurance policies, understanding how dividends work is crucial. Unfortunately, many life insurance agents use dividends as a selling point by making misleading claims or exaggerating potential returns. This lack of transparency has contributed to the poor reputation that insurance agents have developed over the years.

The Truth Behind Dividend-Paying Whole Life Insurance

Dividend-paying whole life insurance can be a valuable financial tool when understood, but marketing around these policies often includes half-truths and misleading assertions. To protect yourself from purchasing a policy that doesn’t serve your needs, it’s important to understand what whole life insurance dividends are and how they actually benefit policyholders.

What Are Whole Life Insurance Dividends?

Dividends in whole life insurance are not guaranteed. They are, in fact, a distribution of a portion of the insurance company’s profits to participating policyholders. The insurance company’s board of directors determines whether dividends will be paid each year based on the company’s financial performance. If the company doesn’t perform well, dividends may be reduced or even eliminated.

When a policyholder receives dividends, they can be used in several ways:

• Purchasing additional paid-up insurance
• Reducing premium payments
• Accumulating at interest
• Taking as cash
• Paying down policy loans

Considerations When Shopping for Dividend-Paying Whole Life Insurance

Before purchasing a policy, ask yourself these questions:

1. What premium is comfortable for you to pay? Make sure the premium fits comfortably within your budget, whether paid monthly or annually.
2. When will you pay your premium? Monthly payments may be more manageable for cash flow, but annual payments often come with a discount.
3. How will dividends be applied in the policy? Understanding the dividend options and which one is set as the default is important.
4. Where will earned dividends benefit you most? Different dividend options can help achieve various financial goals.

Comparing Dividend Projections

Let’s examine a real-world example to illustrate how dividend projections can be misleading. Recently, a prospect approached McFie Insurance having been shown a policy with impressively high dividend projections. Let’s compare that policy (Policy 1) with an alternative recommendation (Policy 2).

Policy 1: The High Dividend Projection

This policy required $100,000 per year in premiums for 10 years. After 10 years:

• Guaranteed cash value: $952,624 ($47,376 less than total premiums paid)
• Guaranteed death benefit: $3,333,793
• Projected dividend in year 10: $33,157
• Non-guaranteed cash value would grow from $1,007,156 in year 9 to $1,146,569 in year 10
• Total projected dividends over 10 years: $180,495

The agent heavily emphasized these impressive dividend projections to make the sale.

Policy 2: The Better Value Proposition

This alternative policy also required $100,000 per year for 10 years, but with different guarantees:

• Guaranteed cash value after 10 years: $1,003,228 (higher than Policy 1)
• Guaranteed death benefit: $4,641,245 (significantly higher than Policy 1)
• Projected dividend in year 10: Only $4,038
• Total projected dividends over 10 years: Just $7,673

At first glance, Policy 1 seems better because of the higher dividend projections. This is where the deception often occurs.

The Dividend Efficiency Problem

Let’s analyze how efficiently these dividends translate into actual cash value growth:

Policy 1:

• Year 10 dividend: $33,157
• Cash value growth in year 10: $139,413 ($1,146,569 – $1,007,156)
• Cost per dollar of cash value growth: $0.2378 ($33,157 ÷ $139,413)

Policy 2:

• Year 10 dividend: $4,038
• Cash value growth in year 10: $125,503 ($1,011,250 – $885,747)
• Cost per dollar of cash value growth: $0.0322 ($4,038 ÷ $125,503)

This means Policy 1’s dividends are over 7 times less efficient at generating cash value! For every dollar of cash value growth in Policy 1, it costs the policyholder nearly 24 cents of their dividend, compared to just about 3 cents in Policy 2.

Focus on Guarantees, Not Projections

When evaluating whole life insurance policies, it’s crucial to focus on the guaranteed values rather than non-guaranteed projections. Guarantees are contractual obligations that the insurance company must fulfill, while projections (including dividend projections) are possibilities that may or may not materialize.

In our example:

• Policy 1 provided higher guaranteed cash values in years 1-6
• From year 7 onward, Policy 2’s guaranteed values significantly outperformed Policy 1
• Policy 2’s guaranteed death benefit was higher than Policy 1’s throughout the entire contract

The Long-Term Perspective

Whole life insurance is a lifetime contract, so it’s essential to consider the long-term performance, not just the initial years. Policies designed to maximize early values often do so at the expense of long-term growth.

By year 15:

• Policy 1 would require $1,051,597 in total premiums with only $1,061,727 guaranteed cash value
• Policy 2 would require only $1,000,000 in total premiums (no premiums after year 10) with a guaranteed cash value of $1,172,979

This means Policy 2 requires less premium while guaranteeing more cash value and death benefit in the long run. The policy with lower dividend projections provides better guaranteed value to the policyholder!

Misleading Claims About Whole Life Dividends

Claim 1: “Dividends are like getting a return on your investment”

Truth: Dividends aren’t technically investment returns. According to the IRS, life insurance dividends are considered a “return of premium” rather than investment income. While this classification is beneficial for tax purposes (dividends usually aren’t taxable), it’s misleading to present them as investment returns.

Claim 2: “Our company has paid dividends for over 100 years without fail”

Truth: While some insurance companies have impressive dividend payment histories, past performance doesn’t guarantee future results. Economic conditions change, and even companies with long dividend-paying traditions can reduce or suspend dividend payments if financial conditions warrant it.

Claim 3: “Our dividend rate is higher than our competitors”

Truth: Dividend rates between companies aren’t directly comparable because:

• Companies use different formulas to calculate and allocate dividends
• The impact of a dividend on cash value growth varies widely between policies
• A higher dividend rate doesn’t translate to better policy performance

Claim 4: “Higher dividends mean a better policy”

Truth: As our example demonstrated, a policy with lower dividend projections can provide better guaranteed values and more efficient cash value growth. Higher dividend projections mask less favorable guaranteed values or other policy features.

Claim 5: “These dividend projections show what you’ll receive”

Truth: Dividend projections are just that—projections. They are neither guarantees nor promises. Market conditions, company performance, and board decisions all influence actual dividends paid. Many policies never achieve their illustrated dividend projections.

The Balancing Act of Policy Design

A well-designed whole life policy balances early cash value growth with long-term performance. Short-sighted policy design that prioritizes early values often sacrifices long-term growth potential, which is problematic since whole life insurance is intended to be a lifetime financial tool.

Agents emphasize early policy performance because:

1. It makes for an easier sale
2. Early surrender is profitable for the agent (they’ve already earned their commission)
3. Consumers tend to focus on short-term results rather than long-term guarantees

A reputable agent will help you design a policy that balances your short-term needs with optimal long-term performance. This balance occurs long after the agent has earned their commission, which is why working with a trustworthy, client-focused agent is crucial.

Why This Matters

Understanding the truth about dividend projections matters because whole life insurance is a significant financial commitment. These policies often involve premiums of tens of thousands of dollars over many years. Making a decision based on misleading dividend projections can result in:

1. Overpaying for underperforming coverage: Getting less guaranteed value for your premium dollars
2. Unrealistic expectations: Setting yourself up for disappointment when dividends fail to meet projections
3. Missed opportunities: Choosing a flashy policy with high dividend projections over one with better guaranteed values and more efficient performance
4. Potential future financial strain: If a policy requires ongoing premiums beyond what was initially planned, it could create financial hardship

How to Protect Yourself

To avoid falling prey to misleading dividend projections, follow these steps:

1. Compare guaranteed values: Look at the guaranteed cash values and death benefits across different policies, not just dividend projections.
2. Calculate dividend efficiency: Determine how efficiently dividends translate to cash value growth in each policy you’re considering.
3. Consider the entire contract period: Don’t focus solely on the first 5-10 years; examine how the policy performs over decades.
4. Ask about dividend history: While not a guarantee of future performance, a company’s dividend history provides insight into its dividend reliability.
5. Work with a transparent agent: Choose an agent who willingly explains the benefits and limitations of dividend projections.
6. Seek a second opinion: Have another knowledgeable financial professional review any policy before purchasing.

The Bottom Line

Dividend-paying whole life insurance can be a valuable component of your financial plan when properly understood and implemented. It’s essential to look beyond flashy dividend projections and focus on guaranteed values, long-term performance, and overall policy efficiency.

Don’t be swayed by high dividend projections alone. Instead, assess how efficiently those dividends translate to actual policy benefits and consider the guaranteed values that the insurance company is contractually obligated to provide. A policy with modest dividend projections but stronger guarantees and more efficient cash value growth often provides better long-term value.

Education is your best defense against misleading sales tactics. Take the time to understand how whole life insurance works, mainly how dividends function within these policies. By doing so, you’ll be better equipped to select a policy that truly meets your financial goals, rather than one that looks impressive on a sales illustration.

Remember, whole life insurance is a long-term financial commitment. The policy you choose should provide value throughout your lifetime, not just in the early years when the agent is earning their commission. A properly designed policy balances early cash value with long-term growth, providing living benefits and a death benefit that serve your financial strategy.

Tomas P. McFie DC PhD

Tom McFie is the founder of McFie Insurance and co-host of the WealthTalks podcast which helps people keep more of the money they make, so they can have financial peace of mind. He has reviewed 1000s of whole life insurance policies and has practiced the Infinite Banking Concept for nearly 20 years, making him one of the foremost experts on achieving financial peace of mind. His latest book, A Biblical Guide to Personal Finance, can be purchased here.