How to Build Passive Income with Life Insurance Dividends

When you hear the word passive income, what are the first thoughts that enter your mind? Rental properties or stock market investments or perhaps a side business? I want to introduce you to the powerful and commonly-misunderstood tool for financial freedom: life insurance dividends. Yes, the same product that has been created to safeguard and protect your family can also make a potent engine in the generation of a passive income stream for you.

For more than a decade now, I’ve been walking clients through the maze of financial products, and I’ve experienced the power of a well-structured life insurance product as it can turn from a life insurance safety net into a powerful wealth-building investment. This of course is not a get-rich-quick scheme. It’s a strategic approach to financial stability and needs a long-term strategy.

In this guide, we’ll use this and break down how exactly you can use life insurance dividends to provide you a secure future to build from. We’ll discuss what they are, what type of policy you need and the step by step process to make this financial instrument into a reliable source of income in your retirement years.

What Exactly Are Life Insurance Dividends? (And Why Aren’t They Guaranteed?)

First, let’s refute a common misconception. Life insurance dividends are not like the dividends you get from stocks. Stock dividends are a share of the company’s profits given to shareholders.

Instead policyholder dividends are actually a return of part of the premiums you’ve paid. This occurs when the insurance company performs better than they had projected for the year. They are unique to a specific type of company and policy which we’ll explore next.

These dividends are mostly produced from three sources of a mutual insurance company:

1. Favorable Investment Performance: The insurer’s investment of the premiums collected. When these investments work out better than anticipated there’s a surplus.
2. Positive Mortality Experience: If fewer policyholders pass away than the company’s actuaries predicted, then the company pays out fewer death benefits creating savings.
3. Operating Efficiency: Now if the company has less than expected expenses on running the business (salaries, marketing, overhead), the benefit of this surplus is shared.

Because these are changing each year, life insurance dividends are not a guarantee. However, there are several mutual companies that have an amazing track record and have been consistently paying them for over 100 years.

The Key Ingredient: Securing a Participating Life Insurance Policy

You can’t draw dividends out of just any life insurance policy. The magic is the possession of a participating life insurance plan policy from a mutual insurance company.

What’s the difference?

• A mutual insurance company is owned by the policy holders. When the company has a surplus, it “participates” with its owners (you!) in the form of dividends.
• A stock insurance company is owned by the stockholders of the company. Any profit is also typically distributed to these external investors, and not the policyholders.

This is why it is equally important to choose the right company as it is the right policy. Before you make a commitment, you should always opt for smarter choices in terms of safety before investing in any plan. The most common type of participating life insurance policy is the whole life insurance.

Whole Life vs. Other Policies: Why It Is Crucial for Dividends

This type of policy is a cash value life insurance that is long lasting. It’s designed to last your whole life, and builds up a cash value component that grows on a tax deferred basis. This cash value is the engine on which your dividend-generating machine is built.

• Term Life Insurance: This is pure protection (as it is for a specific term only such as 20 or 30 years). It has no cash value and is non-dividend payment. It’s affordable but does not provide any kind of wealth building features.
• Universal Life Insurance: This is another type of permanent insurance, but it is flexible in premiums and death benefits, sometimes resulting in performance that is less steady than whole life and so this is a different vehicle entirely.
• Whole Life Insurance: This is the perfect choice if you are investing in a dividend strategy. It provides guaranteed premiums, a guaranteed death benefit and guaranteed cash value growth. The potential whole life insurance dividends are the icing on the cake that are not guaranteed.

For those who are serious with this strategy, a whole life insurance dividends policy stands as the cornerstone.

How Your Life Insurance Dividends Are Calculated by Your Insurance Company

The calculation for life insurance dividends is a complex process of mathematics and it is best to think of life insurance dividends in simple terms. At the end of each year the board of directors of a mutual insurance company examines the financial performance of the company.

They study their investment returns, mortality outcomes and operational expenses. If there is a surplus, they declare a dividend. This dividend is then distributed to pay the eligible policyholders.

The amount you get is based on the size of your policy and how much it has contributed to the surplus. Generally, the larger the cash value of your policy, the longer you’ve been holding a policy, the larger your possible dividend is going to be. This long term perspective is important for those aiming to grow your family savings without having the loss of future protection.

Your Dividend Payout Choices: Choosing Your Passive Income Approach

Getting a dividend is only the first step. It’s really how you can make use of it that makes its power come out. Most companies have various options and your choice will dramatically make an impact on your journey to creating a passive income stream.

The following are the most common dividend options:

1. Take Them in Cash: The Easiest Option. The insurance company sends you, every year, a cheque to you. This is direct passive income, but it’s to used in a little later “harvesting” years of your plan.
2. Reduce your premiums: You can use the dividend on your next premium payment, which would reduce the out-of-pocket cost to you. This is a great way to make your policy cheaper in the long run. This makes it one of the smarter financial defense tools out there.
3. Buy Paid-Up Additions (PUAs): This is the powerhouse option for accumulation of wealth. We’ll address this in great detail in the next section.
4. Earn Interest (Leave on Deposit): You can leave your dividends with the insurer to earn interest, as would be the case with a savings account. Please note that the interest earned is often considered taxable.
5. Repay Policy Loans: If you’ve used credit lines for your cash value, then you can use dividends to pay down your loan balance.

Comparison of Dividend Payout Choices

The Compounding Power of the Paid Up Additions (PUA‘s)

For the first 15, 20, or even 30 years of your policy the “Buy Paid-Up Additions” option is your best friend.

A PUA is like a mini, paid for life insurance policy that you buy with your dividend. Each PUA that you purchase does three amazing things:

1. It has its own cash value.
2. It has its own death benefit.
3. It is entitled to receive its own future dividends.

By reinvesting your life insurance dividend into the PUAs consistently, you will get a snowball effect. Your policy’s total cash value and death benefit increases from one year to the next. A bigger cash value implies that you get eligible for a bigger dividend the next year, which in turn buys even more PUAs. This is the compounding engine which supercharges the growth of your policy and is a cornerstone of wealth growth through smart risk distribution.

A Step-By-Step process To Creating a Passive Income Stream with Life Insurance Dividends

Here’s Ready to See What it All Comes To. Building this stream of income takes a conscious and four-step approach.

Step 1: Select the Would-be Company and Policies

This is the most critical of all steps. You need a financially strong, long consistent history of paying dividends mutual insurance company. Look for companies with high ratings from companies such as A.M. Best. Where market leaders always need to be compared before a decision is made.

You’ll be getting participating life insurance policy specifically whole life. Work with an experienced agent who has knowledge on how to structure these policies for good early cash value.

Step 2: Structure Your Policy for Maximum Growing of Cash

A standard whole life policy is good but a “high-early-cash-value” design is better. This includes the use of a PUA rider (this permits you to “overfund” the policy by paying more than the base premium).

This additional money is used to purchase Paid-Up Additions from Day 1. This helps to front-load your cash value growth so that the compounding process takes place much faster than with a non front-load option. This is the secret sauce to the concept of dividend paying life insurance as a true asset.

Step 3: Be Patience and Let It Compound (The “Growth Phase”)

For the next 20-30 years, your job is simple: to pay your premiums and make sure your dividend option is set to “Buy Paid-Up Additions.”

During this phase, you are not taking an income. You are building the asset. You will be watching your cash value and death benefit grow exponentially. Your base premium and the PUA rider both power this growth as well as your life insurance dividends being reinvested. It’s also a good idea to occasionally monitor up-and-coming brands that are disrupting the protection market, though it is often important to be stable in this strategy.

Step 4: Switch to Income (The “Harvesting Phase”)

After you have reached your target retirement age it’s time to flip the switch. You contact your insurer and change your option on your dividend from “Buy PUAs” to “Take in Cash.”

Now, rather than being reinvested, the huge annual dividends go straight to your bank account. This becomes a tax-advantaged passive income stream which you may rely on for years to come. Because the basis is so strong, this income will last the rest of your life. This is of course much more reliable than just hoping for the best. For that peace of mind abroad, it’s also a good idea to learn some hidden benefits of travel safety contracts abroad and get them.

Tax Implications of Dividend Paying Life Insurance

One of the most appealing aspects of this strategy is that it is well treated from the perspective of taxation. According to Jordan One, in the IRS, life insurance dividends are normally not counted as taxable income.

Why? The IRS views them as a loan back of your premiums (your cost basis). You can receive dividends free from payroll taxes until the sum you’ve paid in dividends is greater than the sum you’ve paid in premiums. For a policy that is held for many decades, this is a huge advantage. As an outside source, you can find out more on the IRS’s official page about the tax treatment of life insurance proceeds.

When can they be taxable?

• If you leave your dividends on deposit to earn interest, then this interest is taxably paid to pay ordinary income each year.
• If you give up your policy for its cash value, any increase over your cost basis is subject to income tax.

It’s also important to understand how financial regulations may change: it’s a good idea to keep an eye out on changes by the government that can affect your plans in the future. This tax-advantaged status is one reason why dividend paying life insurance is a powerful tool for retirement planning.

Real-World Example: John’s Journey to Passive Income

Let’s make this tangible. Meet John, a professional who is 35 years old.

• The Plan: John buys a participating life insurance policy from a top rated mutual life insurance company. His policy is for high cash value, and for him to pay the premiums for 25 years.
• The Growth Phase (Age 35-60): For 25 years John faithfully pays his premiums. He makes his dividend option to buy Paid-Up Additions. Each year his entire life insurance dividends purchase more of the PUAs, which result in more cash value and larger future dividends.
• The Harvest Phase (Age 60+): During John’s policy at age 60 the policy has significant cash value. He or she has paid off his or her premiums. He calls his insurance company and changes his option for the dividends to “Take in Cash.”
• The Result: John now has a check from the insurance company every year. Let’s say that his annual dividend is $15,000. That’s $1,250 every month of tax-advantaged passive income to supplement his pension and Social Security and all while his policy’s death benefit is still in force to protect his heirs.

This example shows the power of beginning with a well structured policy and having the discipline to allow it to grow.

Risks and Considerations with Life Insurance Dividends

While a powerful strategy this is not without risks and considerations. A balanced view is essential. As a reputable source of financial news, Forbes has a lot to say on the pros and cons of this strategy, and it can be a great outside perspective.

• Dividends Are Not Guaranteed: This is most important point. While leading companies have an excellent track record, poor economic conditions could cause them to pay lower than projected or even no dividends during a given year.
• It’s a Long-Term Commitment: This is not a liquid investment. The drastic cash value increase requires a decade or more time to really take off. You have to be committed to it, for the long haul.
• Policy Costs: Whole life insurance has higher premiums than term life as it’s building cash value. These costs are front-loaded which means that the cash value growth is slow in the first few years.
• Complexity: Structuring these policies in the right way needs expertise. It’s very important to work with a knowledgeable professional and not just an agent selling a generic product. A lack of understanding can cause problems, that’s why it’s important that you look out for yourself when it comes to defending yourself from claims fraud through some simple claim checks and upfront communications with your provider.

When an unexpected event happens it is important to know how to access your benefits. You’ll want to become well-versed in quick payout strategies following any covered incident in order to ensure your financial plan keeps flurrying without a hitch.

Conclusion: Your Path to Financial Freedom With Life Insurance Dividends

The establishment of a reliable passive stream of income forms an integral part of financial independence. While the paths there are numerous, taking advantage of a participating life insurance policy is a time-tested stable and tax-efficient method which too few people know.

The journey requires patience, discipline and the right strategy from the very beginning. By finding a good mutual insurance company and structuring your policy to grow over the life of the policy with PUAs, and allowing the power of compounding to do the thing, you can make a productive asset out of something that is normally a protective asset. It’s about making your policy work for you rather than against you; a matter of turning your policy from a cost to an investment that will repay you for a lifetime.

This strategy isn’t for everyone, but for those with long term vision this offers a unique combination of a death benefit, tax deferred growth and potential for a lifetime of income. The most important is to have a firm plan and stick with it, using your life insurance dividends as tools to create the future that you deserve.

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