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What Are Dividends in Life Insurance?
Much like receiving a dividend when you invest in a public company, a life insurance dividend represents a profit generated by the life insurance company. That profit gets distributed to policyholders. When you purchase a whole life insurance policy, the issuing company invests a portion of your premium money and generates a return on it. Then they return a portion of the revenue to you, as a policyholder, through a cash dividend distribution.
Dividends are different from interest or annuities and are a by-product of a participating whole life insurance policy. They’re not related to other life insurance products. Dividends aren’t guaranteed, and in most cases, it’s not clear how an insurer arrives at a dividend amount. We’ll cover more on the specifics of how dividends work in the following sections.
What Types of Life Insurance Can Get Dividends?
If you’re just starting to shop for life insurance, you might be surprised at how many insurance options are available. Depending on your situation, it might be best to buy a simple term life policy, with a definitive term, affordable monthly premiums and payout amount. You may also be interested in a variable universal life insurance policy that generates investment returns as it provides insurance coverage. But if you’d like a policy that pays dividends, the only option is to buy a “participating” dividend-paying whole life policy.
Whole life insurance is a form of permanent life insurance. That means it stays in place for a person’s lifetime as long as premiums get paid. Whole life is the most common permanent life insurance.
With your whole life policy, part of the monthly premium payments goes toward the policy’s cash value, which builds up over time. As the cash value gets larger and depending on policy details, you can take out a loan against the value or withdraw money while you’re still alive. If you withdraw money, there could be tax implications. Consult an insurance agent or financial professional before making a withdrawal.
The premium amount of a whole life policy doesn’t change, and in certain conditions, you can use policy dividends to pay future premiums. While whole life policies are more expensive than term options and often require a medical exam before you can get approved for coverage, the cash value allows you to recoup a portion of the funds you paid into premiums over time.
How Whole Life Dividends Work
Before we dive into whole life dividends, know that not every whole life policy generates dividends. The distinction is whether you have a participating or a non-participating policy.
When you have a participating whole life insurance policy, you’re considered a stakeholder in the insurance company. As a stakeholder, the company can use the money you pay into the policy to invest with, and if they have a successful year you might receive a dividend. Many companies use their track record of paying consistent dividends as an incentive for customers to use their services and to show their financial strength. For example, New York Life advertises making annual dividend payments since 1854.
The other purchase option for a whole life policy is a non-participating policy, which doesn’t pay dividends. Why would someone opt out of dividends? The answer: a non-participating policy has a lower premium. The choice boils down to what’s more important to the policy owner, a low, fixed premium that won’t change or a slightly higher premium with the chance for dividends to offset the higher cost.
When a policyholder picks a participating policy, chances are they’ll receive a dividend of some amount, assuming they chose a reputable life insurance company. Even so, an established track record of dividends doesn’t guarantee future dividends.
The insurance company is the sole determinant of any dividend. The board of directors decides whether to pay a dividend and how much. The amount depends on how much money the company made in the past fiscal year, its level of expenses for the previous year and its cash reserves to cover upcoming debts and contractual obligations.
Dividends on life insurance policies are usually displayed as a percentage when released. The percentage dividend is based on your policy value. If, for example, you own a whole life policy with a death benefit of $100,000 and a life insurance company issues a dividend of 0.5%, you would be entitled to a dividend of $500.
How to Use Life Insurance Dividends
When policyholders receive a dividend, they have a few options on how to use the money. A common option is to let the dividend cover a portion of the next outstanding premium. Depending on how your policy reads and how your financial institution operates, it’s possible to leave the dividend as a “credit” on your premiums owed. This way, you pay less per month and keep your coverage.
Another way to handle dividends is to take the dividend in cash. You can do this by requesting that the financial institution underwriting your life insurance policy send you a check. You can then cash that check and use the money for any purpose you wish.
Some people use their dividends to add more insurance coverage to their existing policy. In this instance, the term used is “paid-up additions” because the funds from the dividend pay for the additional coverage, and the policyholder’s premium remains unchanged. Over time, the interest compounds, and the increased value for the combined policy can be significant.
Are Life Insurance Dividends Taxable?
In most cases, the Internal Revenue Service doesn’t tax whole life dividends. Because a dividend payout is a return of insurance premiums you’ve paid in the past, the IRS considers dividends to be a return of funds you’ve already paid tax on through your federal and state income taxes.
But there are rare exceptions. Some are based on how the policy is written. If your dividend returns exceed the amount of premiums you have paid, there is a potential income tax implication. Working with a tax professional can help you use your whole life insurance dividends effectively while also avoiding excess taxes.
The Bottom Line
In a whole life insurance policy, receiving dividends can make a big difference in the overall cash value of the policy or the amount of premiums due if they’re paid out over time. Because insurance companies use premiums to make investments, policyholders are often entitled to dividends based on returns. But dividend payments from any life insurance policy are never guaranteed.
If you’re shopping for the right insurance policy and receiving dividends is important for your financial goals, find an insurance company with a track record of paying dividends to policyholders consistently. Review an insurer’s history of dividend payments before you pick which company offers the best policy option for you.
When you receive a dividend, you can use it to purchase more prepaid insurance, put it toward your premiums or receive it as cash. While the right choice for any consumer depends on their circ*mstance and financial goals, choosing to purchase paid-up insurance with your dividends can cause interest to compound and significantly increase the policy’s cash value over time.
Frequently Asked Questions About Life Insurance Dividends
When choosing between a participating (dividend-eligible) or non-participating policy, consumers must determine if potential dividends are worth the increased monthly premium. While that decision is dictated by a person’s financial goals, a participating policy can be worth it if you want to offset future premium costs or increase the cash value of the policy by putting the dividend toward paid-up additions.
Dividends are paid to consumers as a share of profits made by a company. Interest can be defined as money due to the holder of a loan or a person’s ownership in a company. Dividends are usually not taxable, although interest is. The insurer makes a decision on whether to pay dividends. But payouts from interest and distributions are written into the terms of a loan contract.
A death benefit is a part of any insurance policy due to the beneficiaries of the policy upon the death of the policyholder. The amount of the death benefit is predetermined, but in certain policy types, there can be an additional cash value to the policy to be paid out along with the death benefit.
A life insurance dividend is only available to people with a participating whole life insurance policy. Dividends are returns on the insurance company’s investment performance. They are not guaranteed but are paid on an annual basis with most companies.
The main drawback of a policy with dividend potential is simple: it costs more per month. The good news about a participating policy eligible for dividends is the potential for returns that are tax-free or tax-deferred. If you just want money back in your pocket, want to put it toward your premiums or buy more insurance with it, a dividend can be beneficial if it’s paid consistently.
While some policies have more nuance than others and are underwritten differently, in most instances dividends are paid on the anniversary of the day the policy took effect. Remember that dividends are not guaranteed, even if you’re eligible for them.
Methodology: Our System for Ranking the Best Life Insurance Companies
Our goal at the MarketWatch Guides Team is to provide you with comprehensive, unbiased recommendations you can trust. To rate and rank life insurance companies, we created a thorough methodology and analyzed each company by combing through online policy information, speaking to agents via phone, reading customer reviews for insight into the typical customer experience, and reviewing third-party financial reliability scores.
After collecting this data, we scored each company in the following categories: coverage, riders, availability and ease of use and brand trust. To learn more, read our full life insurance methodology for reviewing and scoring providers.
Sarah HorvathAuthor
Sarah Horvath is one of the home service industry’s most accomplished writers. Her specialties include writing about home warranties, insurance, home improvement and household finances. You can find her writing published through distributors like HouseMethod, Architectural Digest, Good Housekeeping and more. When not writing, she enjoys spending time in her home in Orlando with her fiance and parrot.
