There are many different options when it comes to life insurance policies, ranging from comprehensive whole life to limited-term policies. While term policies are usually the cheapest form of life insurance, whole life policies offer a number of benefits that policyholders may want to consider, including a guaranteed death benefit, predictable premiums over time, and even dividends that can provide cash or help offset the cost of insurance over time.
- Permanent life insurance policies often pay dividends to their policyholders on a regular basis.
- Dividends received will be based on the performance of the company's financials, based on interest rates, investment returns, and new policies sold.
- The dividends can be distributed as cash, to purchase additional paid-up insurance, or to reduce premiums due.
What Are Dividends?
Many whole life insurance policies provide dividends representing a portion of the insurance company’s profits that are paid to policyholders. In many ways, these dividends are similar to traditional investment dividends that represent a share of a public company’s profit.
The dividend amount often depends on the amount of money paid into the policy. For instance, a policy worth $50,000 that offers a 3% dividend will pay a policyholder $1,500 for the year. If the policyholder contributes another $2,000 in value during the subsequent year, they will receive $60 more for a total of $1,560 next year. These amounts can increase over time to sufficient levels to offset some costs associated with the premium payments.
Whole life insurance dividends may be guaranteed or non-guaranteed depending on the policy, which means it’s important to carefully read through the details of the plan before purchasing a policy. Oftentimes, policies that provide guaranteed dividends have higher premiums to make up for the added risk to the insurance company. Those that offer non-guaranteed dividends may have lower premiums, but there’s a risk that there won’t be any dividends in a given year.
Finally, policyholders should consider the credit rating of the insurance company itself when determining how sustainable dividends are moving forward. Most insurance companies are rated A or better by major credit agencies. Those below an A rating may warrant a closer look to determine whether the insurance is sufficient or not.
Using Policy Dividends
There are many different options when it comes to using whole life policy dividends, ranging from a check in the mail to acquiring additional insurance. The most common uses of dividends include:
- Cash or check: A policyholder may request that the insurer send a check for the dividend amount.
- Premium deductions: A policyholder may request that the dividend be put towards their future premiums owed in order to offset the cost.
- Additional insurance: A policyholder may use the dividend amount to purchase additional insurance or prepay on their policy.
- Savings account: A policyholder may decide to keep the dividend with the insurance company in order to earn interest on the amount.
The good news is that dividend payments received from participating life insurance policies generally aren’t subject to taxes by the Internal Revenue Service (IRS) since the insurance companies generated the gains off of their policyholders.
Dividends received from a life insurance policy are treated as a distribution from the contract, and they are taxed similarly to other types of distributions. Dividends are distributed income-tax-free until the taxpayer's investment in the contract has been reduced to zero. (Dividends reduce the owner’s investment in the contract.)
Because the insurance companies generated the gains off of their policyholders In essence, the dividend payments are treated as refunds for overpayment of the premium. This means that the best option is usually taking the cash or check from dividends and reinvesting the proceeds in an investment vehicle that could earn more income.
The Bottom Line
Many whole life insurance policies pay dividends to their policyholders that can be used in a variety of different ways. When evaluating insurance policies, individuals should investigate how dividends are calculated and whether or not they are guaranteed, as well as look at how they plan to handle the dividend income. The favorable tax treatment means that the best option is usually taking the cash and reinvesting it elsewhere at a better return.
Additionally, as there's more to a good insurance policy than its dividend, be sure to review the plan in its entirety to verify that it's the best whole life insurance policy for your circumstances.