Pay for Your Whole Life Insurance Using Policy Dividends

Being the life insurance guy often puts me in a place where I answer questions about dividends.  Turns out a lot of people have a vague understanding that (some) life insurance policies pay dividends so we often answer the questions: “how do you pay for whole life insurance using policy dividends?

If this is a question you've often pondered, you're really going to enjoy what follows.

Participating (Dividend Paying) Life Insurance

First, you have to make sure that the life insurance policy in question is a participating life insurance policy.  The term participating is an esoteric insurance-y term so most of the time you'll hear people refer to it simply as dividend-paying life insurance.  For reasons that will not improve your quality of life in any way–I assure you–the insurance industry decided decades ago to label insurance products that paid dividends “participating policies.”  So any time you see that term, participating, simply think dividend-paying.

Dividend-Paying Whole Life Insurance

Next, we need to make sure that the life insurance policy in question not only pays dividends but that it's the right kind of dividend-paying life insurance.  That product is dividend-paying whole life insurance.

If the life insurance policy in question is any other type of life insurance–most likely term life insurance or universal life insurance–then unfortunately there's an extremely small chance that you'll be paying any premiums with dividends.  While some of these products are issued with the ability to earn dividends, the amount that they earn in dividends is generally small and never enough to pay the entire policy premium (but keep reading if you fall into this category because I'm going to address some other options later that might work out for at least some of these other types of life insurance).

Now that we've established that you have a dividend-paying whole life insurance policy, we can continue on to how you go about paying the premium with the dividends.

The Dividend Option to Reduce/Pay Premiums

All dividend-paying whole life insurance policies permit four dividend options; they are:

  1. Paid in Cash
  2. Purchase Paid-up Additions
  3. Reduce/Pay Premium
  4. Accumulate at Interest

You might already be able to guess which one among the list is the one you want.  The option to reduce/pay premiums will accomplish your goal.

The process is actually extremely easy and straightforward.  As the policy owner, you simply call the insurance company and tell them you'd like to change your dividend option to the one that pays your dividend.  The customer service people can handle making this change to your policy.

Once the change takes place, you will continue to receive your annual policy statement and the premium due notice, but the insurance company will handle paying the premium with your dividend.

There are a few critically important notes about using this dividend option.

Paying Whole Life Premiums with Dividends Check List

First and foremost you must have a dividend paid on the policy that is at least equal to the policy's premium amount.  If the dividend is less than the premium amount, the insurance company will allow you to pay a portion of the premium with the dividend, but you'll still be responsible for the remaining amount the dividend doesn't cover.

In either event, the payment frequency of the policy must change to annual.  So if you were paying the premium monthly, you'll need to change the payment frequency to annual and the dividend will pay the premium annually.

There are a few implications to this worth noting.

You will save money.  Just like most other life insurance policies, paying premiums at a frequency more than annually costs you some money.  The insurer is making you cover the assumed lost investment income they incur by not having all the money upfront.

Using the dividend option to pay premiums comes with a requirement that the premium is paid annually.  This is good news, it will eat up less of your dividend as a result of the annual payment savings.

But if your dividend is not large enough to cover the entire premium payment and you are instead using the dividend to reduce your premium and then cover the remaining amount with your own money then you will still need to use the annual payment frequency.  I want to use an example to draw your attention to an important consequence of this.

Imagine that you a currently paying a $1,020 per month premium and decide to use your dividend payment to reduce your premium, which paid annually is $12,000.  Your dividend is currently $6,000.  This means you will need to make a $6,000 payment to the policy to cover the remaining premium and you cannot spread this out over a 12 month period.

Additionally, you should understand that most life insurers will only allow you to make the change necessary to pay your premium with dividends once per year at the policy anniversary date.  So if you are currently three months into your current policy year, you'll need to wait an additional nine months before changing the dividend option to use your dividend to pay the premium.

In some cases, the insurer might have a pro-rated schedule to allow the change mid policy year, but this is not a universal practice.

Lastly, the dividend payment might exceed the premium amount (often the case for older whole life policies).  In this event, you will need to make a secondary dividend option from the remaining dividend options.  You are free to choose whichever one you want, as none of them will further affect how you go about paying the premium with the dividend.

Alternatives to Paying Your Premiums with Dividends

You might be in a place where the current dividend on the policy is not large enough to cover the entire premium.  You have other options if you do not want to or cannot pay the premium due on your policy.

Even if the dividend paid on your policy is large enough to cover the entire premium due, you might still opt for one of these other options.  I'm not going to get into a detailed discussion on when you might choose one of these alternatives over the dividend option to pay premiums.   Largely because it's often dictated by circumstances.

Whole Life Cash Surrender

You can choose to surrender cash value in the whole life policy and use it to pay the premium due on your policy.  Agents often refer to this method as an “offset.”  Functionally the policyholder is surrendering paid-up additions and using the released cash value of those paid-up additions to pay the premium due.

Note I specifically mentioned a surrender of paid-up additions to pay the premium on the policy.  A whole life insurance policyholder cannot surrender the guaranteed cash value accumulation of the policy unless he or she chooses to surrender the entire policy.  In other words, any cash surrenders made with a whole life policy that does not intend to cancel the entire contract require the surrender of paid-up additions.  If the policy has no paid-up additions cash value (i.e. it only has guaranteed cash value) then a partial surrender under any circumstances is not permissible and therefore a surrender to pay premiums due is not permissible.

The process for using a surrender of paid-up additions to pay premiums involves the policyholder's instructing the insurance company to do so.  Usually, some paperwork is required that often will note that surrendering paid-up additions will result in a loss of outstanding death benefit.  This happens because surrendering paid-up additions for their cash value also means the policyholder surrenders the death benefit associated with those paid-up additions.

The option to surrender cash to pay premiums does not generally require that the premium be paid annually, but I would generally advise against paying premiums under some other frequency and using surrendered cash value to pay them.  This will result in a larger than necessary drawdown on policy cash value due to the charge the insurer assesses for paying under frequencies other than annually.

However, a circumstance could arise where a policyholder who pays premiums monthly (for example) falls on rough financial times and does not have the money to pay the monthly premium.  In this situation, it could make sense to use a cash surrender to cover premiums and those premiums would be paid on a monthly schedule.

Paying Whole Life Premiums with Policy Loans

Similarly to paying the premium with surrendered cash value, the policyholder could also choose to pay premiums with a loan from his/her policy.  There are two key differences when using a loan versus a cash surrender.

First, the policyholder can pledge guaranteed cash value as collateral for the policy loan, so the distinction between guaranteed cash value and cash value created by paid-up additions no longer matters.

Second, policy loans do accumulate interest, so these options might not be the best bet if there is no plan to eventually repay the loan.

For a lot of whole life insurance policies, an automatic provision exists to pay the premium due through an automatic premium loan if the policyholder fails the premium within the grace period following the premium due date.  This means the insurance company will automatically original a loan and pay the premium due with no action required by the policyholder.  The industry refers to this feature as an automatic premium loan.

You should note that while this is a default option for a lot of whole life insurance policies, it's not necessarily a default option for all whole life insurance policies so you should check with your insurance company to determine if the automatic premium loan feature is active on your policy.  If it's not, you can change that by requesting the insurer do that (generally over the phone with a customer service representative).

If a whole life policy is not set up for an automatic premium loan, then one of the non-forfeiture options will activate, and the default is almost always extended term insurance.

While most loans used to pay premiums occur through the automatic premium loan, there might be some situations where this isn't the case.  Initiating this process requires little more than calling the customer service department and requesting a loan while specifying that it is for the purpose of paying the next premium due.  In most cases, the insurance company will take care of everything from there.

Using the Reduced Paid-Up Option (RPU)

All whole life insurance policies allow an option to reduce the death benefit on the policy and change to paid-up status.  This feature is usually electable by the policyholder at any time during the policy's existence (with a few exceptions I'll address shortly).

Triggering the reduced paid-up option means the insurer will calculate the death benefit the policy can guarantee for the insured's entire life given the current amount of cash value accumulated within the policy.  This new amount of life insurance (less than the amount at the time of the election) will remain in force (guaranteed) with no future premiums required (i.e. it is paid-up).

Making the election to change to reduce paid-up status comes with important consequences.  Most importantly this option is irrevocable.  Once a policyholder has changed a whole life policy to paid-up status he/she cannot later change his/her mind and reverse the status.

No future premiums are due and no future payments to the policy can be made (including payments to a paid-up additions rider).

The policy will be eligible to continue to earn dividends, so cash value and death benefit can grow larger than the values upon reaching reduced paid-up status.  This is, however, not guaranteed to happen.  There are several life insurers with a long track record of paying dividends to policyholders including those with policies in reduced paid-up status, but you should always know the payment of dividends comes with no guarantee.

Some insurers might require that the policy is in force for a set number of years before the policyholder can elect to change to reduce paid-up status.  If this is the case, the policyholder cannot choose this feature until the policy reaches the required number of years active.

Whole Life Insurance Dividends Offer You Options

The bottom line is that owning participating whole life insurance affords you options when paying the premiums in the future. And fortunately, the dividends within the policy are what creates that flexibility for you.

You can have the dividends pay all or part of the premium (at some point), or you can use other myriad options such as the automatic premium loan (APL), partial cash value surrender, or even exercise the reduced paid-up option (RPU). In every case, the dividends inside the participating whole life policy that builds the cash value so effectively provide those options to you.

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