The IRS regards a life insurance policy dividend as a premium or rebate return. Generally speaking, it is taxed once the total dividends distributed exceed the premium paid personally by the owner. The insurance company’s board of directors determines the dividend based on the business’s financial performance.
Dividends from life insurance can be unclear. This frequently occurs because insurance brokers and insurance firms compare dividends to stock dividends while discussing them. However, a dividend from a life insurance policy is different from a payout from a stock or stock mutual fund.
What Is a Life Insurance Dividend?
Dividends from life insurance can be unclear. This frequently occurs because insurance brokers and insurance companies compare tips to stock dividends while discussing them. However, a dividend from a life insurance policy is different from a payout from a stock or stock mutual fund.
The most important lesson is that the insurance business discloses the percentage of profits given as dividends. Expect an explanation of how the firm arrived at the dividend amount since this calculation is not public. Dividends aren’t always promised.
What Types of Life Insurance Get Dividends?
Policies with whole life insurance may be eligible for dividends. When purchasing whole life insurance, ask whether the coverage is “participating” or “non-participating.” Dividends are only payable to participating policies.
A participating policy has a higher premium but rewards the policy owner with consistent dividend payments.
In addition to paying no dividends, non-participating plans typically have lower premiums than participating ones.
How Can I Use My Life Insurance Dividends?
You can often select a dividend option when purchasing a participating policy. Additionally, once the policy is in effect, most insurers permit changing the dividend option. You could even select a mix of choices.
The most popular dividend alternatives are listed below. Check the dividend alternatives on any life insurance policy you are considering purchasing. Not all of the options below may be available to you.
Dividend payment in cash
Any dividends are available to you as a cash payment option. After each anniversary of your policy, the insurance provider will pay you a cheque if you choose this option.
Reduce your future premium payments.
With this choice, the insurance provider immediately deducts future premiums from any earnings. Your needed premium payments will reduce as dividends rise. If the insurance policy performs successfully, dividends may match or even surpass the cost of premiums. You aren’t required to pay anything out of pocket when dividends surpass the amount of premium that is payable.
Leave the dividends with the insurance company and collect interest
In this case, the insurance company would keep the payout and invest it to earn interest in a dividend accumulation account. Although there is a minimum guaranteed interest rate, it is possible to receive a higher rate.
The announced dividend interest crediting rates for the whole life insurance firms Barry Flagg measures presently range from as high as 6% to as low as 3.38% and average 4.83%, according to Barry Flagg, president and creator of Veralytic, a life insurance analytics firm.
From this account, money can be taken out whenever you want. The account balance is added to the face value of the insurance and distributed to the beneficiaries if the covered individual passes away.
The account balance is included in the net cash surrender value when life insurance is surrendered. Regardless of whether you withdraw the money, the interest you have accrued on the dividends is fully taxable as soon as you have the option to do so.
Buy paid-up additional life insurance.
You could buy tiny sums of additional fully paid-up life insurance using your dividends. This supplementary coverage will include the same kind of life insurance as your initial policy.
The insurance provider will determine the additional coverage the dividend money can buy based on your age. You won’t pay an additional fee or undergo another life insurance medical examination. These paid-up additions can produce their dividends.
Buy one-year term life insurance.
You might buy as much one-year term life insurance as possible using the money from your dividends. Your age and the amount of dividend money will determine how much coverage you can acquire in this method.
You won’t need to undergo a medical checkup for this additional life insurance. This one-year term policy may be useful if you require temporary, small-scale life insurance.
Repay policy loans
You can use your dividends to pay the loan interest and/or principal if you have taken out a loan against your life insurance policy.
Are Life Insurance Dividends Taxable?
Dividends from life insurance are not taxable. They are regarded as tax-free premium returns. However, the interest gain is taxable if you receive interest in addition to your dividends.
Should I Choose a Life Insurance Company Based on Dividends?
The possibility of dividend distributions should not be considered while selecting a life insurance firm or policy. According to Flagg at Veralytic, comparing dividends between two insurance companies is difficult.
The firms predict future costs while setting rates for entire life insurance plans. These estimations are typically much higher than what the final costs end up being. These overcharged expenses are refunded in dividends and any additional interest accrued over what was anticipated.
Typically, insurance firms won’t provide any information about the process used to declare their payouts.
Remember that dividends are purchased and paid for when or where you buy a participating whole life insurance policy. Expect to pay greater premiums if your life insurance policy is eligible for dividends.
How to Use Life Insurance Dividends
Policyholders who qualify for life insurance payouts have a variety of options for how to spend their money:
- Cash Payment: This choice offers the easiest way to use your dividends. You will receive a cheque from the insurance provider for the dividend sum. You can use this money for whichever purpose you see fit, including saving for your future needs.
- Buy Paid-Up Additions: You can use dividends to buy more life insurance with this choice. The benefit in this situation is that these additions are entirely paid up, eliminating the need for additional premium payments and raising your policy’s death benefit and cash value.
- Reduce Premium Payments: You can reduce out-of-pocket costs by applying dividends to your insurance premium. By lowering the amount you have to pay yearly, this can make your insurance coverage more affordable.
- Collect Interest: Allowing interest to build up on your dividends within the policy can be a wise decision for long-term growth. The dividends are kept in a policy account where they accumulate interest over time, raising the policy’s overall value. As long as money stays in the procedure, the interest on life insurance dividends is often not taxable. When you withdraw the claim, it will be subject to tax.
- Invest in One-Year Term Life Insurance: Investing your dividends in one-year term life insurance is another choice.
- Repay Policy Loans: You can use your dividends to pay off any loans you may have taken out against your life insurance policy. This can be especially helpful because it lowers your overall loan balance without needing you to make any out-of-pocket payments. It’s a valuable method for managing policy loans while keeping the policy’s advantages. Utilizing profits to pay off unpaid policy debts can assist in protecting the total value of your approach for your beneficiaries by preventing the death benefit from being reduced.
The Bottom Line
Receiving dividends can significantly impact a whole life insurance policy’s overall cash value or, if distributed over time, the amount of premiums owed. Policyholders frequently qualify for dividend payments depending on investment performance because insurance companies utilise premiums to fund their operations. However, no life insurance policy’s dividend payments are ever guaranteed.
Find an insurance provider with a history of consistently paying dividends to policyholders if obtaining dividends is crucial when choosing the correct insurance policy for your financial objectives. Before deciding which insurer offers the greatest coverage option for you, look at the company’s dividend payment history.
You have three options when you get a dividend: you can use it to pay for premiums, get more pre-paid insurance, or get cash. The best decision for each consumer will depend on their situation and financial objectives. However, investing profits in paid-up insurance can compound interest and long-term growth in the policy’s cash value.