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Understanding Life Insurance Dividends


Unlocking the potential of your whole life insurance policy goes beyond your interest rate – it’s about leveraging the power of dividends. These payouts provide policyholders with additional benefits and financial opportunities. Life insurance dividends are payments you can receive as cash, use to reduce premiums, earn interest or buy more coverage. Here are the details and how to discern the best purpose for your dividends. If you’re wanting to apply this information to your own situation, consider working with a financial advisor.

What Are Life Insurance Dividends?

Life insurance dividends are payments an insurance company sends to policyholders when it turns a profit through its investments. Dividends are not a guaranteed part of the life insurance policy, but they can provide additional benefits to the policyholders. For example, the policyholder can lower future premium payments with dividends, receive them as cash payments or leave them untouched to accumulate interest.

Whole life insurance policies with “participating” status are the sole insurance type eligible for dividends. “Non-participating” whole-life policies don’t offer dividends with the tradeoff of lower premium costs.

How Life Insurance Dividends Work

When you purchase a participating whole life insurance policy from an insurance company, you become a policyholder and a part owner of the company, eligible to receive dividends. Typically, at the end of the year (or quarter, depending on the company), the insurance company’s board of directors determines whether to declare dividends and the amount to distribute. Here are the three factors influencing your life insurance company’s dividend payout:

  • Dividend Interest Rate Credit: Whole life insurance companies generate income by investing customers’ premiums in a portfolio. If these assets appreciate, the company sets aside dividend payments for policyholders based on a preset rate.
  • Mortality Credits: Second, the company figures in its mortality component for the year. So, if the company had fewer claims than it predicted at the beginning of the year, it paid out fewer benefits. On the other hand, an abundance of claims and the associated payouts will leave the company with less profit to distribute as dividends.
  • Company Expense Debit: Next, the insurance company has operational expenses to address. As a result, efficient companies with less waste and investment fees will produce higher dividends.
  • Individual Policy Value: Lastly, the insurance company considers your individual policy. The higher the cash value of your policy, the higher your dividends.

Remember, these factors fluctuate, meaning dividends aren’t guaranteed. The ebb and flow of business can prevent a company from sending dividends. Plus, each company decides its own dividend calculations, so the same amount of surplus cash can result in unequal dividend payments among different companies. Therefore, it’s crucial to shop around and ask about dividend payment calculations when purchasing a whole life policy.

How to Use Your Life Insurance Dividends

Here are the different ways you can use life insurance dividends:

  1. Receive a Cash Payment: Your insurance company can pay you the dividend amount in cash. You can use this money immediately however you like, such as covering daily expenses, paying off debts, investing or saving for future goals.
  2. Reduce Your Future Premium Payments: Dividends can also reduce your future premium payments. This option means the insurance company deducts the dividend from your upcoming premiums, lowering the out-of-pocket cost of maintaining the policy.
  3. Leave the Dividends With the Insurance Company and Collect Interest: Instead of taking a dividend in cash, you can leave it with the insurance company for further financial benefit. The company will hold the dividend and return a specific interest rate over time. This way, the dividend increases the policy’s cash value. You can access your accumulated dividends in the future by withdrawing them or using them to improve the policy’s benefits.
  4. Buy Paid-Up Additional Insurance: You can also use the dividends to purchase paid-up additional life insurance, increasing your policy’s death benefit and cash value. This option expands the benefits and financial protection your policy provides. Life insurance companies consider paid-up additions fully paid, not requiring further premium payments.
  5. Buy One-Year Term Life Insurance: In some cases, insurance companies offer the option to use dividends to purchase one-year term life insurance. This temporary coverage enhances your existing policy for a specified period (typically one year). It provides an additional death benefit for that duration. This option allows you to increase your coverage temporarily without committing to permanent changes in your policy.
  6. Repay Policy Loans: If you have outstanding loans against your life insurance policy, you can use dividends to repay them. Doing so reduces or eliminates the loan balance, which helps maintain the policy’s cash value and death benefit.

Tax Treatment of Life Insurance Dividends

Understanding Life Insurance Dividends

Whole life insurance dividends are generally not taxable. For instance, receiving dividends as cash isn’t taxable as long as they don’t surpass the total premium amount you’ve paid over the years. However, dividends can be taxable when your cash payments exceed the total premium you’ve paid. In addition, earned interest on dividends is taxable income.

Remember, buying paid-up insurance puts the money back into your policy, allowing tax-sheltered growth. Plus, growing the policy’s cash value enables higher dividend payments in the future.

When It Makes Sense to Buy Life Insurance With Dividends

It may not be clear when you should choose to buy life insurance with dividends. In addition, it’s not always so cut and dry and it’s important to assess your personal needs before moving forward. As an example, here’s a set of situations where it makes sense to use dividends for paid-up insurance:

First, buying paid-up additional insurance (PUA) boosts your policy’s growth. This perk is a godsend for whole life policies because they usually take at least 12 years to break even with premium payments. However, dividends can halve the time required for this process and then continue providing exponential growth. Therefore, PUA is beneficial for newly purchased policies.

Second, PUA is permanent. It doesn’t increase your future premiums or expire. It also increases the death benefit of your policy. So, in the event of your death, your beneficiaries would receive a higher payout. Remember, death benefits are typically tax-free.

In addition, purchasing more life insurance augments your policy’s permanent death benefit. Because insurance companies base dividend payments on your policy’s cash value and permanent death benefit, reinvesting dividends helps create higher dividend payments in the future. Practicing this habit for years causes your policy’s income-generating power to snowball.

You can also borrow against your policy’s cash value as needed. These loans aren’t considered taxable income, don’t affect your credit and have lower interest rates than other loan types.

Remember, how much PUA your dividends can purchase depends on your age and the health rating your company assigns you. So, getting a whole life policy earlier in life and putting dividends to work as soon as possible increases your purchasing power, maximizing your PUA capacity.

The Bottom Line

Understanding Life Insurance Dividends

Life insurance dividends offer policyholders additional benefits and financial opportunities within their whole life insurance policies. While dividends are not guaranteed, understanding how they work and the factors influencing their payout can help you make informed decisions. Generally, purchasing PUA is wise because it enhances your policy’s value without raising costs.

Life Insurance Dividends Tips

  • Whole life insurance is a costly commitment. As a result, it’s vital to research companies offering policies and reviews other asset classes to ensure it fits your situation. A financial advisor can help you identify your financial goals and build a plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Dividends are a unique perk for whole life policies. However, term life insurance can be cheaper, allowing for more flexibility. Here’s a comparison of term vs. whole life insurance to help you decide.

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