Whole life insurance policies not only cover a person indefinitely, but they can also pay dividends. As a policyholder, you can either receive these payments in cash, use them to offset future premiums or even purchase additional coverage with the money. But before committing to a dividend-paying whole life insurance policy, it’s imperative to understand how they work and your potential tax liability. It also may be worth enlisting a financial advisor to help you determine the right type of policy for you.
What Is Whole Life Insurance?
Unlike term life insurance, which has a defined coverage period, whole life insurance ensures coverage for the entire lifespan of the policyholder, assuming the premiums are paid. For instance, if a 30-year-old purchases whole life insurance, they’ll be covered for as long as they pay their premiums – whether they live to 70, 80 or beyond. Whole life insurance premiums remain the same for life, but are typically more expensive than term insurance premiums.
In addition to a death benefit, whole life policies include a cash value component that grows over time and can be accessed during the policyholder’s lifetime. This is an added bonus that differentiates whole life insurance from term insurance. It’s this cash value component that attracts many people to whole life insurance, as it not only provides them with added security but also potential growth of their savings over time.
How Dividend-Paying Whole Life Works
However, whole life insurance policies may also have the added benefit of paying dividends. Should an insurance company report a profitable year, it may redistribute a portion of these earnings to whole life insurance policyholders on an annual basis. This profit-sharing methodology often depends on the company’s investments, expenses and capacity to manage risk effectively.
The dividends that whole life insurance policies pay can either be guaranteed or non-guaranteed. However, whole life policies that pay guaranteed dividends will typically have more expensive premiums than those that do not guarantee their dividends.
Dividend Payment Options
You can choose to receive your dividends in a variety of ways: claim them as cash, use them to reduce your premiums, secure additional insurance or let them accrue interest. Here’s a closer look at the various dividend payment options:
Choosing the cash dividend payment option offers several benefits. First, it provides policyholders with immediate access to funds. This liquidity can supplement their income or help cover unforeseen expenses.
Cash dividends are generally not subject to income tax, offering a unique advantage in terms of taxation. This can result in substantial savings compared to other taxable investment options, contributing to the policy’s financial efficiency.
Premium reduction is another compelling way to use the dividends from a whole life policy. Policyholders can instruct the insurance company to apply the accumulated dividends to offset future premium payments. By consistently choosing the premium reduction option, policyholders can potentially see their coverage remain intact even as their premium costs decrease.
Paid-up Additional Insurance
Instead of receiving dividend payouts in cash, you can choose to funnel them back into your policy for additional coverage. This means that over time, your policy’s death benefit can increase substantially. It’s like giving your life insurance a boost to ensure your loved ones are even more protected.
One of the key advantages of paid-up additional (PUA) insurance is its potential for cash value growth. These additional payments accumulate cash value over time, which can be borrowed against or withdrawn if needed.
Furthermore, PUA offers a level of flexibility that can align with your changing needs. As your financial situation evolves, you can adjust the amount of PUA coverage, tailoring your policy to suit your life stages. This adaptability sets PUA apart as a dynamic and customizable option.
Accumulate at Interest
When policyholders opt to accumulate their dividends at interest, they essentially allow the insurance company to retain the funds on their behalf. Over time, these accumulated dividends accrue interest, steadily boosting the overall value of the policy. This can serve as a form of reinvestment, potentially leading to a more substantial financial gain in the future.
Opting for the accumulation at interest option presents several advantages. First and foremost, it fosters a disciplined savings approach. The accrued dividends, along with the added interest, can create a reliable savings pool that may be accessed at a later date, offering a degree of financial security.
Furthermore, the reinvestment of dividends, coupled with the compounding interest, can potentially yield a more robust financial outcome over time compared to immediate dividend payouts. This can be particularly advantageous when considering long-term financial goals, such as supplementing retirement income or funding educational expenses.
Are Whole Life Insurance Dividends Taxable?
Generally, life insurance dividends are considered a return of premium rather than income. As a result, they are typically not subject to income tax. This makes them an attractive option for policyholders seeking to accumulate wealth without incurring immediate tax liabilities.
However, if you decide to leave your dividends with the insurance company, they may accumulate interest over time. The dividends themselves remain tax-free but the earned interest is taxable. Keep in mind that this interest is only taxed when it’s withdrawn, allowing for tax-deferred growth similar to other investment vehicles.
Dividend-paying whole life insurance combines permanent coverage with the prospect of additional cash flow. Someone with this type of policy can receive their dividends in cash, use them to reduce their premiums, earn interest or use them to purchase more insurance. Keep in mind that dividend-paying whole life insurance is often more expensive, especially if the dividends are guaranteed.
Tips for Buying Life Insurance
- It’s important to understand the differences between term life insurance and permanent life insurance. Use this comprehensive breakdown when deciding which variation is right for you.
- A financial advisor can help you assess your needs and even help you buy life insurance. 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.
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