CFP

As a general rule premiums paid for life insurance policies by individual owners are considered personal expenses and therefore, not deductible from income. Also, premiums paid for business life insurance (key person life insurance) usually are not deductible. The few exceptions to this rule are:

• Premiums paid for life insurance owned by a qualified charitable organization
• Premiums paid as an alimony decree from an ex-spouse (deductible as alimony).
• Premiums paid for life insurance as collateral security for a debt by a business creditor are deductible.
• Premiums paid by an employer for employee group life insurance as an employee benefit expense.

DIVIDENDS
Definition: If you own a participating life insurance policy, you are entitled to receive dividends. Not all policies are participating. Mutual companies do not have stockholders; instead, they are owned by their policyholders. These companies set their initial premium amounts at a level that will cover their contractual obligations, operating expenses and unexpected losses. When the premium charged is too high, you, as a participating policyholder, receive an equitable share of the distributable surplus. Your share in any distribution of surplus is called your policy dividend. You may elect to receive your dividends in cash, or, depending on the type of policy you have purchased, you may elect to use dividends to:

• Take dividends in cash - Dividends become payable on contract anniversary dates and are usually sent automatically in the form of a dividend check after company approval.
• Apply dividends against premium payments - Applying dividends to premium payments generally lowers the owner's out-of-pocket expense.
• Allow dividends to accumulate at interest - Can be withdrawn at anytime; however, any interest paid on them is taxable income in the year the interest is credited to the policy.
• Use dividends to buy paid-up additions - Dividends can be used to purchase additional life insurance, of the same kind, but premium rate is based on the age of insured at the time paid-up insurance is purchased.
• Use dividends to purchase one-year term insurance - This is done through the issue of a separate rider.

Generally dividends distributed by insurance companies are not taxable; they are instead a return of premium and reduce the policyowner's basis. There is an exception to this rule, in that if dividends exceed premiums, the excess amount of dividends are taxed as ordinary income.

Practice Question:
A policy that pays dividends is called what?

A. Participating policy
B. Term with premium return policy
C. Guaranteed renewable policy
D. Flexible premium policy

Answer: A
Participating policies pay dividends