Updated: Oct 15, 2020
And here's another myth to be busted. "Dividends are just a return of unused (overcharged) premium." This is a myth perpetuated by those who do not understand the underlying economics within a cash value life insurance contract, but we'll go ahead and explore where this came from and why it's true... and false, all at the same time.
Cash value life insurance has some of the GREATEST benefits in the tax code. As such, every few years, it comes UNDER ATTACK by members of the United States Congress in order to raise more revenues (increase taxes).
NAIFA and other life insurance lobbyists helped to define the tax treatment of dividends to let the Internal Revenue Service classify dividends as a "refund of unused premium" rather than a taxable return, so that the tax benefits can be preserved and protected for current and future policy holders.
Those who continue to perpetuate this myth claim that "whole life insurance is a ripoff because they are just returning your own money back to you and call it a 'dividend'." If that was really the case, common sense would say that the dividends STOP after they refunded all your money back, right?
But the dividends DON'T stop! (Okay, let's be clear - they are not guaranteed because they are based on the mortality experience (death claims) of the past year, operating expenses, and general investment account performance.)
Here is a page from a maximum-funded whole life insurance illustration. This was a male, age 35, standard non-smoking illustration paying $10,000 a year for 30 years (until age 65). The neat thing about this particular illustration is that it has a column for cumulative dividends (total dividends being paid to the contract owner per the illustration using the current dividend scale. Dividend scales can be increased or decreased according to the performance of the company).
Here is the page out of the illustration. (Obviously this is not a quote for coverage, nor a solicitation, nor an official policy. The name of the company and other information has been removed.)
By age 65, we would've paid in $300,000 into the contract. By end of age 76 (11 years later) the total dividends paid to the contract owner says $308,068!) So let's total up the total benefits, shall we? - Paid in $300,000 over a total of 30 years. - Age 76, we have an estimated $834,242 in cash values.
- Age 76, we have an estimated total dividend payments of $308,068. - Age 76, (assuming no loans), we have a total net death benefit of $1,250,194 payable to your beneficiaries income tax free!
- And the dividends, cash values, and net death benefit continue to grow, even though we stopped paying into the policy.
The bottom line on dividends is this: Even after you "got all your money back"... you still have tremendous values built into this contract that continue to grow for you. I once heard it said that "Life insurance is essentially FREE... because we PAY YOU to keep it!"