Cash Value Life Insurance - A Different Kind of Dividend

I have previously explored a number of the dubious marketing claims that swirl around cash value life insurance (CVLI) – a broad category of life insurance that tries to double as an investment. Here, I’ll explore the allure of the "participating" CVLI policy.

Recall that the premiums associated with CVLI are generally higher than they would be for a similarly-sized term insurance policy offering pure life insurance coverage. This is so because a portion of the higher premium associated with CVLI stays within the policy as a form of policyholder savings. What if, instead of a standard CVLI policy, your insurance salesperson offered you the opportunity to pay an additional 20% in premiums so you could then "participate" in the financial successes of your life insurer through the receipt of policyholder dividends? You and your insurer would then be partners in profit and the policyholder dividends you would receive would also be (in most cases) tax-free. Sounds pretty good, right? Let’s take a closer look.

According to the U.S. Treasury and the IRS, life insurance dividends are not considered to be dividends in the commercial sense of the word. That is, they do not represent a distribution of profits until they exceed the policyholder’s basis in the policy. To draw a parallel, income tax refunds are also generally tax-free for the same reason – not because they represent some type of profit, but because they are really just a refund of an overpayment.

Like an elixir that contains little more than river water, life insurance dividends are more likely to represent a return of one’s money than a return on one’s money. So then, why pay that extra premium to the insurer in the first place?