90/10 Whole Life Insurance and Dividends: Friend or Foe?

Dividend paying whole life insurance can be an amazing asset to own. But there are particular details which must be understood about policy design which allow a policyholder to manage cash flow better while increasing total cash value and face value in the most effectual manner.

Over the course of analyzing thousands of dividend paying whole life insurance policies, there are some common factors noted which all policyholders should understand.  Here are two of the most common factors.

1)    There is a vast disparency between dividends paid and how dividends affect the face value and cash value growth in a policy

2)    Adding term riders onto a dividend paying whole life insurance contract isn’t necessarily in the policyholders best interest

For example, a policy recently reviewed, which was designed with a term rider to increase first year cash values to 84.4% of the first year’s paid premium, ended up severely altering the cash value which the dividends were able to purchase.  In this case, the 10-year dividend of $33,157 produced a mere cash value gain of $139,413 and the net death benefit increased by $216,536.  This represents a 320.50% return on the dividend payment in relationship to the cash value increase, and a 553.1% return on the dividend payment in regard to the increased death benefit.

Comparing this “90/10” policy to a dividend paying whole life insurance policy without a term rider, but with a maximum paid-up insurance rider, we discovered for this same person, a policy issued at the same time as the “90/10” policy and paying the same premiums would experience,

1)    First year guaranteed cash values equal to only 66.76% of the first year premium,

2)    A 10-year dividend of $4,038. 

3)    $4,038 of dividend increased the net cash value of the policy by $125,503 and the net death benefit increased by $208,828. 

This represents a 3,008.0% return, not 320.5%, on the dividend payment in regard to net cash value and a $5,071.6% return, not a 553.1%,  in regards to net death benefit.

The importance of thinking in percent, rather than dollars and cents, becomes critical when evaluating what type of returns a policy will, or is, generating.  Misunderstanding that a larger first year guaranteed cash value or larger dividend payments will be the better policy, can lead someone to losing control over their cash flow while creating a potential loss of growth in their policy.  

A policy which allows the policyholder to manage the most of their money while providing the greatest percent increase in cash value and death benefit compared to the dividend paid is the one which provides the best solution for the policyholder.  This is true regardless if the policy is a “90/10” policy or if the dividend payments are higher than a “60/40” policy. 

In this case study, the “90/10” policy provided 18% more guaranteed cash value than the “60/40” policy was able to provide in year one, yet the “60/40” policy provided higher guaranteed death benefits.  Cash value in the “60/40” policy end of year one was equal to 66.76% of what had been paid in premiums. Yet the guaranteed death benefit it provided was 42.2% more than was provided in the “90/10” policy.  By year ten, the amount paid for both policies was identical.  But the “60/40” policy outperformed the “90/10”policy by 5.02% by year 10 in guaranteed cash values.

If the purpose of owning a “90/10” policy is to be able to leverage those higher cash values immediately, then policy loan interest must be taken into consideration.  Having to pay interest for a policy loan taken against those higher cash values significantly increases the cost of capital.  

In this case there was roughly 18% more money to borrow in year one from the “90/10” policy compared to the “60/40” policy. Leveraging this extra 18% of cash value over just a 2-year period at 6% will increase the cost of capital on this additional money by 9.09%.

Understanding these facts about “90/10” and “60/40” whole life policy designs can help someone determine which policy design best suits their needs.  Not all dividends are profitable and not all high cash values are your friend.  Don’t let dividends fool you and don’t allow the high cash values provided by using a term rider in the design of a dividend paying whole life insurance policy become your foe.  Understand these facts and you will protect yourself from purchasing a dividend paying whole life insurance policy based solely on first year cash values or its dividend projections.   

Finally, yet another fact to consider is the guaranteed death benefits.  In this “90/10” policy, at the end of year 10,  the guaranteed death benefit is only 71.83% of what the guaranteed death benefit is for the “60/40” policy.  Death benefits comparisons fare even worse for the “90/10” policy after the term rider is eliminated due to the ever-increasing costs a term rider adds to the premiums of a “90/10” policy.

In conclusion, it is obvious, why someone should never purchase dividend paying whole life insurance based merely on:

1.     The dividend projections provided in the sales illustration, or

2.     Higher cash values which are derived from adding a term rider to a whole life policy

When looking for a dividend paying whole life insurance policy one should

1.     Pay the highest annual premium which is both affordable and comfortable for them to pay

2.     Minimize the death benefit as much as possible without triggering taxes

3.     Fund a paid-up insurance rider as much as the IRS will allow without creating a tax liability, and

4.     Shun using a term rider to increase first year cash values

When these four principles are adhered to, the policy will perform better, your cost of capital will remain lower, and dividends will become your best friend.  Ignoring these four principles can turn your dividend paying whole life insurance policy into your financial foe.  These four principles, when followed, will allow the dividends earned to generate the most value for the policyholder instead of the insurance company, prevent a policyholder from having to pay unneeded interest for the use of capital, and in the long term produce higher cash values and death benefits for the policyholder.

At McFie Insurance we educate, sell, service, and review life insurance contracts for anyone who wants to maximize the benefits of owning life insurance.  Call us at 702-660-7000 to find out if your life insurance policy is working best for you.