Life insurance is a powerful estate planning tool with many applications for a client’s personal and corporate affairs. A policy’s cash values also provide the client with planning opportunities that can demonstrate the tangible benefits of life insurance in their lifetime.

While the most tax-efficient way of accessing a life insurance policy’s cash values is with a collateral loan, this article focuses on cash dividend (participating whole life only) versus policy withdrawal. There’s something to be said for the simplicity of money in and money out of a policy without having to deal with loan applications, capitalizing interest costs, margin calls and renewals when structuring a collateral loan.

With a participating whole life policy, paid-up additions (PUA) are the most common dividend option, but you can elect to have the dividend paid to the owner in cash. You can also elect PUA at time of issue, then change the dividend option to cash at some point in the future after the base premium ceases (with whole life guaranteed 10 or 20 pay). Cash dividends are tax-free up until they exceed the adjusted cost basis (ACB) of the policy; then they become fully taxable.

With the policy withdrawal option, cash withdrawals can be requested from the policy’s cash surrender value (CSV), which can lower the death benefit over time depending on how much you withdraw relative to what is credited. A taxable disposition will occur when the CSV exceeds the ACB. (For partial surrenders, the ACB is pro-rated based on the amount withdrawn above the policy accumulating fund or CSV, depending on when the policy was issued.)

The following table explains the key differences between the two options. Note that the cash dividend option is available only on a participating whole life policy, while a policy withdrawal is available on both par and non-par whole life, and universal life policies.

Table: Cash divided versus policy withdrawal

Cash dividend Policy withdrawal
Death benefit no longer increases Death benefit continues to grow assuming withdrawals (outflow) are less than credits (inflow) to policy
Tax-free until adjusted cost basis (ACB) is nil, then fully taxable Pro-rated taxation until ACB is nil, then fully taxable
Requires underwriting to switch from cash dividend back to paid-up additions Does not require underwriting to stop policy withdrawals
If elected post-issue, the base cost must end before cash dividend is available (i.e., it cannot be elected on a life pay whole life policy) Available at any period and any cost plan type (G10, G20, life pay)

Assume a non-smoker male, age 50, deposits $100,000 for 10 years, and cash dividend or policy withdrawal starts at year 15 (age 65). Let’s compare the cash divided versus policy withdrawal on a guaranteed 10 pay participating whole life policy, and compare those values against policy withdrawals from a non-participating whole life policy (where cash dividends aren’t available).

The main objective is to show benefits to the policyowner during their lifetime, so comparisons will include cumulative after-tax net income, before-tax cash surrender values and death benefit, in that order.

Effect on cumulative net income

The following graph shows the par whole life cash dividend payout at current -1% versus maximum policy withdrawal at -1% on both the par and non-par whole life policy. The withdrawals are net of taxes.

Graph 1: Effect on cumulative net income from cash dividend versus withdrawal
Click on the image to enlarge it.

Based on this analysis, cash dividends provide greater cumulative net income than policy withdrawals on a par whole life policy over the period, including expected mortality. However, in the non-par whole life example, the policy withdrawal provides greater net income than the par whole life for both cash dividend and policy withdrawal over the same time frame.

Effect on cash surrender value

Now consider the overall impact of cash values from a stress-testing perspective. Clients looking at these strategies would likely want to make sure the CSV can stand the test of time and continued downward pressure on interest rates.

Graph 2: Effect on cash surrender value from cash dividend versus withdrawal
Click on the image to enlarge it.

Based on this data, cash dividends look attractive against policy withdrawals on a par whole life plan. This may be another reason why cash dividend is the way to go with a par whole life policy.

However, when stacked against a non-par whole life policy, the policy withdrawal looks very compelling from a stress-testing perspective from current to -1% compared to a par whole life cash dividend option. The -1% CSV of a non-par policy withdrawal looks very competitive against the par whole life plan at current rates.

Effect on death benefit

Finally, the third most important aspect is the short- and long-term death benefits before and after electing either option.

Graph 3: Effect on death benefit from cash dividend versus withdrawal
Click on the image to enlarge it.

Based on these results, the cash dividend option does not fare well at current or -1% in terms of long-term estate planning benefits in comparison to the non-par cash withdrawal. For all intents and purposes, the policy effectively becomes a T100 with CSV as soon as you change the dividend option from PUA to cash dividend at year 15. This presents the greatest amount of risk to the client since there is no more upside benefit to this estate by electing the cash dividend option.

Policy withdrawals seem to generally provide better estate values with either the par or non-par whole life, excluding for the -1% par cash withdrawal. As such, the question comes down to how the policy looks from a stress-testing perspective from current to -1% or lower.


This hypothetical client will need to weigh the pros and cons of cash dividends versus policy withdrawals in a par whole life policy, versus the pros and cons of a policy withdrawal from a non-par whole life policy. Key attributes like CSV, death benefit and after-tax income potential should be matched with the client’s overall planning objectives, as trade-offs may arise.

If the client elects the cash dividend option but no longer wants to receive the income later on once it becomes fully taxable (when ACB hits zero), the client’s overall tax-planning situation may be affected.

As an example, passive investment income from the cash received in a corporation may impact the small business tax rate. For individuals, income may trigger the clawback of Old Age Security or may not be required given RRIF minimums.

The challenge, then, becomes getting the client through medical underwriting at an older age in order to switch back to PUA. Obviously, the older the client becomes, the more challenging it will be to go through medical underwriting.

With that said, there is something appealing about this strategy to access cash values even if it may not be as tax-efficient as other options such as collateral loans. For clients who may fall somewhere within the affluent market spectrum — but not quite ultra-high net worth — there is some value in this option for accessing funds that’s worth exploring.

Pierre Ghorbanian, MBA, CFP, TEP, is the advanced markets business development director at BMO Insurance.