When shopping around for an insurance policy, you may see information about a policy's death benefits or cash value, especially if you're considering either term life insurance or whole life insurance. But there's another potential benefit you may want to explore: life insurance dividends.
Dividends can make a policy more valuable, allowing you to leave an even greater financial legacy for your loved ones. Curious to learn more? Here's some of what you need to know about life insurance dividend options.
What Is a Life Insurance Dividend?
A life insurance dividend is a benefit that may be paid on some whole life insurance policies, which are a type of permanent life insurance.
With whole life insurance, you pay premiums on a set schedule and coverage stays in place until the policy matures. These policies include a cash value component that can grow tax deferred over time.
Some whole life policies pay dividends when the insurance company performs well financially. In these cases, the company may share part of its profits with policyholders.
Policies that pay dividends are called participating policies, but not all insurers offer them. Some companies issue only dividend-paying whole life insurance, while others also offer term life policies that pay dividends.
Dividends should not be the only factor when choosing a policy. It can help to review how dividends are declared, how they are calculated, and whether they are guaranteed.
How Are Life Insurance Dividends Determined?
Dividend calculations vary by insurer. In most cases, insurers base dividends on their financial performance, including:
- Cash flow
- Expenses
- Investment returns
- Mortality experience
- Number of death claims paid during the year
Your policy coverage also affects dividend amounts. Higher coverage generally results in higher dividends. Dividends are usually paid annually on the policy anniversary, but amounts can change from year to year based on insurer performance.
What Is a Dividend Scale?
A dividend scale explains how insurers calculate dividend interest rates and payouts. It shows the dividend you may receive in the current year and estimates future dividends if expenses, investment returns, and mortality remain consistent.
Insurers may update the dividend scale during periods of economic volatility or when market conditions affect expectations. Dividend scales are often available on an insurer’s website. If not, you can request a copy from customer service.
How Are Dividends Taxed?
Life insurance dividends are generally not taxable as income because the IRS typically treats them as a return of premium.
Dividends may become taxable if they exceed the total premiums paid into the policy. This can occur if the policyholder withdraws cash value, takes out a policy loan, or surrenders the policy.
If a policy is classified as a modified endowment contract (MEC), most dividends are taxable unless they are used to pay premiums or purchase paid up additional insurance. In this case, the IRS taxes dividends that represent a gain, calculated as the difference between the policy’s cash value and total premiums paid, minus any prior tax free withdrawals.
Are Dividends Guaranteed?
Life insurance dividends are not always guaranteed. Whether dividends are paid depends on the policy terms and the insurer’s financial performance. Strong company results may lead to dividends, while weaker years may not.
When evaluating dividends, it helps to look at an insurer’s track record and financial strength. Credit ratings can offer insight into a company’s stability and ability to meet long term obligations. Rating scales differ by agency, but higher ratings are generally associated with stronger financial positions.
If the insurer is publicly traded, reviewing quarterly filings and annual results can show whether dividends have been paid consistently or reduced over time. Many large mutual insurance companies have a long history of paying dividends, in some cases for more than 100 years.
Whole life policies typically have higher premiums because they include cash value and the potential to receive dividends. Reviewing an insurer’s financial health can help you decide whether dividend paying whole life coverage aligns with your goals.
How Do Outstanding Loans Affect Dividends?
If your policy has cash value, it allows you to access funds through withdrawals or policy loans during your lifetime.
That flexibility can come with tradeoffs. Borrowing from your policy can reduce dividends, depending on how your insurer calculates them:
- Direct recognition method: Dividends may change based on how much of your cash value is loaned out and unavailable for investment.
- Common outcome: In many cases, outstanding loans lead to lower dividends.
People borrow from life insurance policies for many reasons, including paying off debt or investing in real estate. Still, borrowing requires caution. Keep in mind that the more you borrow or withdraw, the less your beneficiaries may receive. Over time, loans can reduce the policy’s overall value. Lower cash value can also limit dividend earnings.
Loans can have an impact on your dividends. Request a Free Life Insurance Quote
5 Life Insurance Dividend Options
You can use life insurance dividends in several ways. Below are five common options available to policyholders.
1. Take a Dividend as Cash
This is the most straightforward option. Your insurance company sends you a check for the dividend amount. You can use the money however you choose.
2. Reduce Your Premium
Dividends can be applied toward your policy premium.1 If your dividend amount is higher than the premium, it may fully cover the cost. Over time, some policies reach a point where dividends handle premiums entirely, reducing out-of-pocket payments.
3. Reduce an Outstanding Loan Balance
If you have a loan against your policy, dividends can be used to pay it down. This option may help preserve more value in the policy so beneficiaries receive the full death benefit.
4. Earn Additional Interest
Instead of withdrawing dividends, you can leave them with the insurer to earn interest. You may withdraw these funds later without reducing the policy’s cash value or death benefit. Interest earned on dividends is taxable and may be subject to income taxes.
5. Purchase Additional Paid-Up Insurance
Dividends can be used to buy additional paid up whole life insurance. This increases your coverage with little to no added cost. Paid up insurance may also earn dividends and build cash value, which you can access or borrow against.
Another benefit is that you can increase coverage without a medical exam or additional health information. Since life insurance costs often rise with age, this option allows you to add coverage without those hurdles.
Is Dividend-Paying Life Insurance Right for You?
Life insurance is designed to help reduce future financial burdens for your loved ones after you pass away. Dividend paying life insurance, also known as a participating policy, includes an added feature that may support this goal.
Dividend rules and rates vary by insurer, and payouts are not guaranteed. Dividends depend on factors such as:
- The insurer’s investment returns
- Operating expenses
- The number of mortality claims paid during the year
Because of this, you may receive a reduced dividend or none at all in a given year.
That said, dividends alone should not be the deciding factor. Whole life insurance offers benefits that apply regardless of dividend performance, including:
- Guaranteed premiums that remain the same for the life of the policy
- Coverage that does not expire as long as premiums are paid
- A potential cash value component that grows over time
These features can make whole life insurance worth considering on their own. Any dividend payout is an added benefit, not the primary reason to choose this type of coverage.
Conclusion
Life insurance dividends can add flexibility and potential value to a whole life policy, but they are not guaranteed and can vary year to year. Understanding how dividends are determined, taxed, and affected by loans can help you set realistic expectations. When evaluating dividend-paying life insurance, it helps to focus first on the policy’s core benefits and view dividends as an added bonus rather than a deciding factor.
Boost your financial flexibility with dividends from life insurance. Request a Free Life Insurance Quote
Sources
- Life insurance dividend payment options. https://www.va.gov/resources/life-insurance-dividend-payment-options/.
