What Is an Accumulation Option?
An accumulation option is a policy feature of permanent life insurance that reinvests dividends back into the policy, where it can earn interest. Some types of insurance pay dividends to their policyholders each year when the insurance company performs better than estimated.
Accumulation options are one of several options policyholders have for what to do with the dividends they receive. An accumulation option is also known as an "accumulation at interest dividend option," "accumulation at interest option," or "dividends on accumulation."
- An accumulation option reinvests dividends back into the policy to earn interest on an annual basis. Death benefits may also increase due to increases in cash value.
- Some insurance policies contain provisions to pay dividends when the company performs better than expected.
- No portion of the cash value is paid at the death of the insured, only the death benefit.
Understanding Accumulation Options
Accumulation options are available to participating permanent life insurance policyholders. Dividends paid as part of accumulation options are considered a tax free return of capital as long as it remains in the cash value ("inside build-up") of the policy.
If portions of the dividends are withdrawn, the amount that is above the "return of capital" would be subject to taxes. However, if taken out as a loan the entire amount would remain tax free. If you're specifically referring to the accumulation at interest account then this state would be accurate.
No portion of the cash value is paid at the death of the insured, only the death benefit. Often times the death benefit may grow as the cash value grows in whole life policies. This effect is due to dividends automatically buying mini insurance policies which will cause the face value to increase. Upon surrender, only the cash value would be available for withdrawal. Taxes would be due if the total cash value is greater than total premiums paid into the whole policy.
A policyholder may also use their dividends to pay a portion of their existing premiums or elect to receive dividends immediately as cash. Although dividends are not guaranteed, some insurance companies have paid them annually to their whole life policyholders for more than 100 straight years.
Some insurance carriers do allow policy owners to pay money directly into the cash value.
Types of Accumulation Options
Here are the five accumulation options in a whole life policy.
- Cash Option: The policyowner receives dividends in cash.
- Reduction of premiums: The policyowner simply subtracts the amount of the dividend from the premium currently due and remits the difference to the insurer.
- Accumulation at interest: The dividends are maintained in the equivalent of an interest-bearing savings account for the policyowner. A minimum rate of interest is guaranteed, but a higher rate of interest may be credited if conditions warrant. The accumulated dividends may be withdrawn at any time. If not withdrawn, they are added to the death proceeds or to the non-forfeiture value if the policy is surrendered.
- Purchase of paid-up additions: Each dividend is used to purchased, on an attained age basis, a small amount of additional, fully paid-up whole life insurance. The purchase is made at rates that do not contain a loading for expenses, and no evidence of insurability is required.
- Purchase of term insurance: Some insurers that offer what sometimes called a fifth dividend option use a portion of the dividend to buy 1-year term insurance equal to the policy's then cash value, with the remainder used to buy paid-up additions or to accumulate at interest. In either case, the term insurance is purchased on the basis of the insured's attained age.
Dividends Beyond Accumulation Options vs. Paid-Up Additional Insurance
Policyholders may also use their dividends to purchase more insurance. This is called paid-up additional insurance.The paid-up addition also builds cash value and earns dividends. The cash value and dividends grow income tax-deferred. Paid-up additional insurance is usually the default option, unless otherwise specified. Paid-up additional insurance increases the total death benefit as well as the cash value the policy owner can either borrow as a loan or receive upon the cash surrender of the policy. This may be a good option for a policyholder that has a family, whose insurance needs will grow over time. Paid-up additional coverage does not require medical underwriting, so it's an easy way to increase coverage even if health declines.
Annual dividends can also be applied towards the premium on the policy anniversary to lower the out-of-pocket cost of the policy. The annual dividend may be larger than the annual premium once the policy has been in effect for a number of years, which would eliminate the out-of-pocket premium requirements.
Example of an Accumulation Option
Tom has a $100,000 life insurance policy with annual premium payments totaling $3,000. He earns $1,000 as annual interest from the dividend amount deposited into the accumulate at interest account maintained by his insurance company. He chooses to reinvest that amount back as premiums. Over time, as the dividend amount increases and interest rates move higher, Tom's premiums are covered by his accumulation options. A few years later, however, interest rates move south and Tom's interest rate account is not sufficient to meet his premium payments.