[00:00:00] Speaker A: Foreign welcome to wealth on Main street, where conversations about growing your wealth are fun and entertaining. Wealth isn't just about money. It's the skills and the knowledge that we develop to pass on to future generations.
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There's always elections every couple of years we go through these big cycles and there's all the news is yelling about the election this way or that way. Whether they're in US or Canada, you're in your local state or your province, everyone's got something to say about the elections today. We're talking about a different kind of election, dividend elections. We get questions every once in a while on what can I use the dividend for in my participating policy. And so it turns out there's actually five different choices. Primarily we're going to talk about those different choices. We're going to talk about why we have things automatically set up for the purpose of the infinite banking concept and incorporating Nelson's principles and what we choose to do with it. But it's important as a consumer that you should be aware, hey, what are the other options and why should I understand them? The more you have the depth of understanding about the product itself, the tool, as Jason likes to say, the more you understand how to utilize the tool and what are the different features and bells and whistles it has. So we're going to talk all about dividend elections today. I know where my vote's going to go, Jay, but we'll summarize and see where everyone thinks their vote will go after we're done our conversation about dividend elections.
[00:01:41] Speaker B: Okay, that sounds cool. And I elect that. I love dividends. That's, that's what I'm electing.
[00:01:48] Speaker A: Do you remember when we, when we first started doing, you know, presentations and stuff and we, we did the first boot camp so many years ago and we talked about the dividend party.
[00:01:58] Speaker B: We sure did.
[00:01:59] Speaker A: Yeah. We actually used to play this clip of Nelson from his 10 hour seminar and we had him, literally, we had that whole section in there in our training is called the Dividend Party. And Nelson would talk about when you get your dividends, they call all the accountants and the rate makers in and they figure out how do we do on, on the numbers this year? Oh, look at that, we got a surplus. We got some money to pay a dividend, you know, and everyone says, oh, it's time for a dividend party. So every year on the anniversary date of the policy, you get the opportunity to receive A dividend. If the insurance company is, number one, profitable, and then number two, the board of directors chooses to issue a dividend. Now, every one of these companies has a dividend policy, which is how they manage that process.
Yeah. But as a participating owner, you're entitled to receive any. A portion of those dividends. If any is paid out, it must be paid out to all participating owners relative to the size of their policy. They got a little bitty policy, little bitty dividend. You got a big policy, you get a big dividend. Yeah.
[00:02:56] Speaker B: And can I frame up something too, before we dive into the five options? So if we use some simple math and we look at a mutual company, so in this case, there are no stockholders, and that company generates $150 million in net income.
So everybody can capture that number. It's an easy number to remember.
And the insurance company decides that of that 150 million, 75 million of that is going to be paid out.
Distributed. I shouldn't say paid out, because if you didn't elect to have it paid out, it's not paid out. So I'm going to use the word.
[00:03:43] Speaker A: Distributed, jumping ahead a little bit. Yeah.
[00:03:46] Speaker B: So 75 million of that gets distributed to the participating policy owners in the form of a dividend.
What happens to the remaining 75 million? It gets added to the participating policy owner's equity.
So when you look at a company and the company indicates, hey, this year we did 150 million in net income, policy owner's equity rose from a billion to a billion, 75 million.
And 75 million was paid out. Again, 75 million was distributed in the form of dividends.
You can quite easily reconcile that math.
Now, why is that important?
Because in a mutual company, the sole beneficiaries of the participating policyholders equity are the participating policyholders. That's why they call it participating policyholders equity.
And so when these companies, which have been in business longer than Rich and I and you as the viewer, the listener, have been alive combined, we can see why the owner's equity grows to be very substantial and it increases substantially each year. Now, of course, the company maintains allocation for continuing capital surplus to have reserves to be able to smooth out dividends that get distributed. But I just wanted to give people a really simple sense of the math.
When a company reports on their financial performance and they report on how much has been paid in dividends, how much the owner's equity in the company, the life insurance company, actually grew because the net income has to be. It has to land somewhere. So A portion of it gets distributed. The remaining portion is added as owner's equity.
[00:05:40] Speaker A: Well, I'm glad you mentioned that. And before we get into our different dividend elections they're called, you mentioned smoothing. And I think that's an important thing which we've done. Another great episode which we can maybe link to somewhere up here about dividends and how dividends are paid and stuff on, on these insurance contracts. And we also did a really good conversation with an actuary at a major mutual life company in Canada and we spoke to him about their dividend policy and how they look at these things from the boardroom perspective, talking about how they go to bat for their clients. Their clients being participating policyholders. Right. So the smoothing impact, I think is really important because, you know, in the world of, you know, financial products, our brain often thinks about the, you know, stock market. It goes up and it goes down and there's all these kind of sick cycles that things go through. Well, the participating account is, has invested assets and they will also go through some of those cycles. And sometimes things are really good and sometimes they're not so good. And there's certain areas of the PAR account where it's a big pie and this part of the pie did really well and this part of the pie didn't do so good. So they blend all that together and the end result is for the year they did this good or that good. Okay. But what, what happens is if they had a downer year, they have all this contingency set aside. So every year when they are profitable, they set aside some money effectively into the equivalent of a contingency fund and they can take from that and they can smooth out those highs and lows. So even if there was a really good year where the investment portion did amazing, they're not going to distribute all that amazingness to the PAR owners that year. They're going to hold some back because there's going to be years where it isn't as amazing and then they're going to top up in those years. So the end result is you have this nice, stable, easy, actually very boring looking line that is so, so consistent that it would make you like almost blind looking at it. I'm like, oh my God, is it supposed to move? Is it supposed to go up a lot or down? Like there's nothing exciting about the line because it's so smooth. Yeah. That it doesn't, you know, attract our sensibilities. Like down in Vegas where they got the bright lights and there's all these bells and whistles and sounds going off at you. Well, that's, it's meant to be boring because that's how it's designed to function and it's been proven to function for, you know, couple centuries really effectively. So don't fix it or no, don't try to fix it if it's not broken, essentially. So just to talk a little bit about smoothing, I think that's important. Now, getting into these dividend elections. So when you, you apply for the policy, you'll get an illustration from the advisor. That's requirement you sign that in your application. You have to choose in the little boxes whether it's digital or online. You're checking a box which is your dividend election. So if you do receive dividends, how do you want them to go? Well, the first option is paid in cash. Now, Jason was talking about that earlier and when he said paid out, what he really means is distributed. And if you choose to check that box, your distribution is then paid out in cash. Now, Jason, what would be some of the potential ramifications of having a dividend paid out in cash?
[00:08:41] Speaker B: That's a really good question.
It would impact the paid up additions that are added to the policy. So if you have your policy structured in a way where a portion of your premium, which is optional, is purchasing a paid up addition to the death benefit, if you received the dividend in cash, whereas I would elect to have my dividend go back in as a paid up addition, then if we had the very same insurance contract, all things being equal, then your addition to your death benefit would be lower because you received that dividend in cash. And it would get to a point in the policy where, whether you're in the United States or Canada, it would get to the point where the dividend being paid out in cash to you would trigger a taxable event.
And so those are the two that come to my mind immediately if I was contemplating taking a dividend in cash.
[00:09:49] Speaker A: Perfect. Yeah. And so at the beginning of the contract, we select what option do you want?
And in the future, potentially you might be able to change that option. So maybe you started with paid up additions, which we're going to get to. We're going to talk, probably spend most of our time talking about that. Let's assume you started there. In a later date, you say, you know what, I don't want that anymore. I want to change my dividend election. You fill in a form, you're at the voting booth and you're electing a new option for your dividend and now you're going to receive it in cash. So now you're going to be dealing with again, most likely a taxable distribution, etc. Etc. Here's the other thing that happens with some companies. If you do elect paid in cash, you may not even be able to pay a flexible paid up additions premium. You might be limited. Depending on the company situation, they might not even give you that option. So that could be a potential ramification. And so if you had been doing that for let's say 20, 30 years and then you change the option, if you wanted to do it again, you might not be able to have that option again. Because for some companies, when you want to pay paid up additions, well, that buys more death benefit and that also has more risk to the pool. So they might need to underwrite that at that time. So every company has slightly different rules. So you need to be aware of those kind of things. When you change these elections, it could have multiple ramifications for you. Okay, let's talk about the next one on the list that I have, which is premium reduction or dividend to reduce premiums. All right, so this comes up. Actually Nelson talked about this with his state farm policy. Now we've talked about his state farm policy he got in 1959. He was, I believe, 28 years old at that time. When he got that policy, the annual premium was $388 a year and it was a $20,000 death benefit. I am doing this from memory, but I'm pretty sure maybe James Nethery will watch this and comment and tell me if I was on, on point.
Um, but for the first 15 years of that contract, that's what Nelson had elected because that's what he was told to do. So every year when he got his dividend, it would reduce some of the, the next year's annual premium. So if his, his premium was 3,88, maybe the next year was only 360 and maybe the next year was only 345. Maybe the next year it was only, you know, 327. So each year it was minimizing that until such a point where the dividend was big enough that it was covering the entire premium and if there was any excess. So let's say the dividend was greater than that. $388, it was $400. Well, he would have paid the premium and the remainder amount would have been issued to him as a cash payment in a check, which he then would have been taxable. So, so that's what premium reduction looks like we're reducing the premium each of a year with the dividend. If the dividend is growing, it reduces more of the premium.
Once the premium is completely reduced and there's nothing more to reduce, the remainder gets spit out as a cash payment at that point in time.
Yep, yep, very accurate. And, and now Nelson would say he would obviously never recommend that. So he actually stunted the growth potential of his state farm policy through the, the, the most important years of that policy, which was the first 15 years. Now when he found out about this, it was when he joined the insurance business and he went, and he went to the voting booth, he grabbed the form from the life insurance company and he changed his dividend election and he switched it back, well, switched it intentionally now to paid up additions. So now going forward, he paid the 388 Premium and every future dividend that he received bought paid up insurance. Now when Nelson passed away, that policy, don't quote me from remember, but I believe, Jason, you might know this, I believe it was around $125,000 to $127,000 in death benefit.
[00:13:24] Speaker B: That's close enough. Yep.
[00:13:25] Speaker A: But his original death benefit was $20,000. Right. He passed away at age 80. So he was 28 years old. He passed away at 88. So he had a pretty 60 year chunk of time basically with that policy. And he grew that policy five times the original death benefit by paid up additions. He didn't have a paid up addition premium. There was no flexible premium. All he had was the base premium that he could pay. That was the power of dividends after he sacrificed the first 15 most formidable years of the policy by stunting its growth.
So just put that into context for a minute. Sure. We're talking about $388, but what if it was $38,000 and that was you today and you had the ability to have those dividends working for you for 60 years. Just think about the scale of the impact that we're talking about with what Nelson stunted in his own life that he could have had and he actually stunted that policy a second time. This is an important thing because we're talking about these dividend elections.
In the early 2000s, Nelson wanted to prove a point. He didn't need the policy loans anyway. He had multiple policies. He changed his dividend election, he went back to the voting booth, he changed his dividend election again and he switched it to pay the dividend in cash. He did that for four years and that was between 2000, I think it was, was it 6, 7, 8, 9 and 10? 2000, 2006, 7, 8, 2006-79, I believe is with the years we have the checks that we don't have them in front of us. But the end result is all the checks that he received recovered all the premiums that he paid for the lifetime of the policy.
And he did that because he wanted to take a picture of the check and use it in presentations as a proof point for people. So he stunted the first 15 years and then he stunted four of the larger years in the back end of his life and he still ended up with more than five times the original death benefit in the policy.
That's pretty impressive. It's brilliant.
[00:15:21] Speaker B: And when he told that story, which he told it so well, I don't know if that story is up on the NNI's YouTube channel, the Nelson Nash Institute YouTube channel.
[00:15:32] Speaker A: It exists in a Freedom Advisor event. It is on the channel. And be able to link it in the description. We'll try to get it put in the description here because I think I have a short link that'll take us directly to it.
[00:15:44] Speaker B: Yeah, because I think it would be amazing for viewers and listeners just to go and hear Nelson himself explain what was going on and just how amazing it was. And he would always say, you know, if you don't believe a check, there's no helping you. And so that's why he had those checks coming in and then he got that phone call.
And I won't, you know, I'll keep people in suspense. They can go and listen to Nelson tell the story. It's very powerful.
[00:16:11] Speaker A: Way better to hear Nelson talk for sure. Okay, so let's get to our third option. So the third option is dividends on deposit. Okay. So there's a distribution. You're choosing to have it on deposit. Essentially the dividend is going on a deposit account, basically like an interest bearing account with the insurance company, but it's a separate account outside of the policy. Right. Okay. And because it's a separate account, it's like you got paid it in cash, except you didn't receive the check. You just said, put it into an account and generate some interest for me. And that interest rate will be set by that company at that time.
So essentially that also will have taxable consequences now because it's a getting paid out to you essentially. And then also now you have the interest bearing income on that account. So a lot of the tax advantages that you can create from the policy. We've now mitigated now here's the thing that we didn't mention in the first couple examples. So in the paid in cash example, the death benefit's not growing, it's level and it's not increasing at all. Right. Now if you had paid up additions and then you changed it, maybe you grew it for a period of time, you changed it later in life and it's now fixed at that point, it'll never grow anymore. So the death benefit becomes flat at that point. Right. Premium reduction, same scenario. The death benefit stays flat, it never grows. Only your premium goes. Premium doesn't even go down, you're just paying less of it. Right. Premium is always the same for the contract. It's just that you're out of pocket for less capital.
Exactly. The end result is once you've tapped out that total premium and they're kicking you out in excess again, there's no reason for the death benefit to grow. So you've fixed and leveled the death benefit and has no accumulation potential.
That also means because of that, the likelihood is you've now stunted all the future potential dividends because you didn't grow the size of the policy in any way. You've also now minimized all the potential of future dividends because you're getting paid your dividend relative to your size of share of the giant pool of ownership of the mutual company, if that makes sense.
[00:18:10] Speaker B: Yeah, well, every paid up addition earns its own dividend.
[00:18:15] Speaker A: Yeah. Base policy earns dividends and every paid up addition earns dividends.
That's how the compound effect really takes place. So we've covered three of the five elements. The next one on our list we've mentioned several times is paid up addition. So those of you practicing this concept, read Nelson's book, read some of our books. We've got a couple of them. By the way, you can go to don't spread wealth.com or grow your own capital.com. you get a couple right there. You can go to cash follows dot com. That's another good one. So we have a lot of great books where we talk about this. In fact, cashflows.com, we actually really dig into this. We have an image kind of talking through the impact of growing paid up additions. Right. That's, you know, if you wanted to put a secret sauce onto this, this tool called Participating Life Insurance, some might say that's the secret sauce, but it's really in how you interact with it that I think is the difference. So paid up additions are exactly that. It's a paid up, meaning it's a one time payment and then it's completely paid for. Addition. We're stacking on an addition to the base policy. So you have a base policy, let's just say it's $500,000. You have a paid up addition, it adds $25,000 of death benefit. Your new total death benefit is 525.
It's like you've added a floor on the property and now you have a new floor. And then each year you're raising the floor up. Each time it's like you're building a skyscraper. And every time that you add a layer on there on one of these extra floors or a LEGO block that you're stacking on top, you're now locking in by contract the insurance company to an increased amount of death benefit. They have a contractual element with you as the policy owner that they are required to grow the cash value, which is your asset that you own.
They are required to grow that asset every single day that you're alive until such a point as the policy matures the maturity date. So that would be the endowment date of 100 in Canada and it could be 121 in the States. Unless you have an older contract, it might be a different, might still be at 100. So, so whatever the contract states, that's when that cash value must grow to equal that amount. And so every time you stack one on, not only are you increasing your dividend potential, you're also automatically locking in a future cash flow. So if I added a, I have a $500,000 death benefit and in year one I had $25,000 of paid up insurance.
I'm now created a $25,000 IOU with the insurance company.
They owe me that $25,000 if I die immediately to my family or they owe it to me in an accumulated cash bucket that they're required to grow. Either way, they're on the hook.
I'm holding the iou. They owe me that at some point in time.
[00:20:52] Speaker B: And to expand on what you just said, if you go back to the figure that I shared earlier, 150 million of net income, 75 million is distributed in the form of dividends.
And let's assume for a moment that 5 million of that 75 was actually paid out in cash.
So that's 5 million that has left the bank account of the insurance company and it has now been paid out to all these people that elected to receive it in cash.
And let's say that there's another 5 million that was left on deposit and now we've got 65 million where the election was paid up additions that 65 less million dollars that are not leaving the life insurance company's money pool. What is the insurance company going to do with that money?
They're not going to let it sit still. They're going to put the capital to work.
So all the advantages of paid up additions that Rich just described, the other massive benefit is that the actual cash, the actual portion of that net income that never went anywhere is being redeployed to go and earn more return on that invested capital.
[00:22:23] Speaker A: And only, only one group of people get the benefit of that return. Participating owners. There's no one else who receives a benefit.
[00:22:29] Speaker B: Right.
So if we, you, Rich and I, we own a company, we have $75 million that we've declared in dividends, and you and I say we're just going to elect to roll that right back in to the business.
Pretty smart decision on our part because now we've got all that much more capital earning a return on capital.
So the very next year we sit down and we go, wow, we did pretty good because we generated a significant return on that capital that we didn't extract in the form of cash and go and spend it.
[00:23:03] Speaker A: Yeah, we generate a return on the business itself plus a return on the capital that we kept in the business. Right.
[00:23:09] Speaker B: So outside of all these great advantages, think like an owner because this is a business.
And just how many millions of dollars are getting redeployed because the policy owner elected to have the dividend buy a paid up addition?
[00:23:27] Speaker A: But.
[00:23:30] Speaker B: There was no financial transaction other than the administrative expense of doing that.
But there was no money that changed hand. The insurance company didn't say, hey, can somebody hold out their left hand?
[00:23:42] Speaker A: Yeah.
[00:23:42] Speaker B: And you put 5 million in it and then can somebody hold out their right hand and the left hand passes the 5 million back like there's, there was no actual transaction.
It's brilliant.
[00:23:55] Speaker A: I love it. I think that's a really important point. I'm glad that you brought that up because, you know, we're talking about this and we're looking at it from the consumer's vantage point. Yeah. But it's not frequently enough that the consumer, especially if they're now an owner in the company, is looking at it from the vantage point of, oh, I'm actually part of something bigger here. What is the, what does that bigger look like? And you've done a really good job of framing that up. Now our fifth version here is, you know the final one we're going to talk about and it can go by different names. Some companies may have this option, some may not. And so in Canada it's often called an enhanced protection.
You might hear it referred to as a blended PUA type of a ride or something like that. And so this is a scenario where essentially the dividend is basically we're adding an extra layer of a term insurance with the, with the policy.
And so it's either increasing the coverage or something to some degree. And, and that is going to almost like an automatically convert. So when the dividend comes in it's going to pay the cost of that term insurance. Often it's done as a one year. So if we had it for this term rider, let's just say is it's added on, it's a unique piece, it's a component built in. And we elect this dividend election. It says, okay, dividend when you come in first job is you're going to pay for the cost of that term insurance this year. If there's anything left over that has after paying for that cost, we're going to automatically convert some of that term insurance into paid up additions.
So it's kind of like you've got this block of coverage. Let's just say the block of coverage is a million dollars.
Year one, we have our dividend. The dividend pays the cost of that million dollar term. Let's just say it was 100 bucks. We had a thousand dollar dividend. We're going to take the remaining $900 and it's going to say okay, now we're going to convert some of that million and we're going to convert 50 grand of it into permanent whole life. So then in year two, you still have the same million dollars of coverage, but only 950 is term and 50 is whole life.
You get the dividend again, it's going to pay for the minimum cost and it's going to auto convert. And so each and every year there's like this conversion element that happens until eventually, hopefully, hopefully if it all works well, all of that term insurance gets replaced and converted over time into paid up insurance. But you maintain a total coverage amount over that whole time frame. Now there's a lot of ways that can be set up and it could be adjusted. Some companies, it could be, say I'll use the word manipulated to a degree. And, and it also is a lot more confusing. So it's not a very common option certainly that we see, but it's an option and there could be a specific use case for that. But you know, it requires a lot more understanding and in depth knowledge to make sure that you're using it appropriately and properly. Yeah, that's probably. You'd only see that where someone really needs a lot more coverage. And by doing it this way they're creating the extra coverage they need and they're also making sure that they're turning that into permanent coverage over some time frame.
[00:26:52] Speaker B: And I own one that I intentionally so of the 77 policies in our family banking system, I own a policy with that dividend election.
And the sole purpose of me doing that and the premium in that particular policy is, is not significant. I think it's somewhere around $5,000 a year. I just wanted to see over a 20 year period what the net effect of that would be compared with the net effect of a high cash value, paid up additions, dividend election, same amount of premium. So I could hold the policies up side by side and say here's what this one looked like after 20 years. Here's what this one looked like after 20 years. So it gives you a frame of reference where it's not going to be the same outcome for obviously for everybody who you know does. It's. For me it was just more so I wanted to have that longer range contrast just to see it, you know.
[00:27:57] Speaker A: And I've had, you know, maybe two unique situations where there was a sensible reason to consider that and it really had to do with a death benefit need. Yeah. Relative to, here's a client, they've got a certain amount of budget that they can apply to premium. We've already added term insurance in place to help fulfill some of that need. However, this little bit of top up is actually going to get us into the end zone and not sacrifice all that premium by going to more term benefit. Right. So there was a, you know, a couple very specific circumstances where I've used it. It's been very selective and the reality is it, it is complex. It requires more education and understanding as how to use that tool. Because like any tool, you put more parts on the tool, it might require more maintenance. You know, you gotta, you got a compound miter saw, well, you gotta change the blade every once in a while. You might have to oil something. You gotta, you're gonna have sawdust, you gotta empty things out. Like there's maintenance required for, for different tools that you use. So the more bells and whistles you add on it, sometimes the more maintenance and the more activity level you need to have an ownership over that as a participating owner. But there we go. I mean, those are the five dividend options.
We can only circum, you know, dial it in to the degree that we really want to make sure it's clear. Paid up additions is clearly. Maybe I have a bias, Jason, Maybe we have a bias on this. I don't know. But I don't think there's a lot of people who would be like, oh my God, paid up additions are the worst. Clearly that paid in cash is the best option. Like, I think it's pretty clear to determine that the paid up additions is by far the most efficient.
You know, whether you're using this tool for Nelson's concept or not. If you just own the tool, period, most likely it is set up that way. That is common. One of the biggest differences that people don't realize is that while the dividend election is helpful, if you had a policy but, and you had that dividend election but you didn't also have the ability to pay additional premium or a flexible premium or more paid up additions, then you won't have the ability to, at your own discretion, increase the potential of that, of that contract. Because here's what a lot of people don't realize. So again, if it's in year one and I have a policy and it's $50,000 a year, I have the privilege to pay in premium.
Maybe my minimum premium is $20,000 as an example and I'm putting 30 as a flexible amount by my choice.
Well, on day one, I haven't received a dividend yet because dividends don't get paid until the anniversary.
If I don't put the 30 in and I only pay the minimum amount of 20,000, the dividend at the end of the year isn't going to be as good.
But if I put the 30 in and I put it at the beginning of the year, at the end of the year, my dividend is much better. And now for every future year, for the rest of my life, it's going to be better because I set the right building block in stone in the first year.
That is human behavior oriented. It has no bearing on the life insurance company. It's all all on the individual.
[00:31:02] Speaker B: Love it.
[00:31:03] Speaker A: Well, I hope you guys enjoyed this and this fun conversation. Make sure you get a copy of growing your own capital using paid up additions as part of
[email protected] growyourowncapital.com and check out this magical video that just popped up right here. Says I'm great content.
[00:31:18] Speaker B: This is fun.
[00:31:20] Speaker A: Okay. You wanna learn how to implement the process of becoming your own banker? It's easy. We put it together in seven steps. The exact educational path you need to be successful in this process.
Go ahead. Go to seven steps ca. That's seven steps, CA. And get your copy of the report right now.
