A Guide to Dividend-Paying Whole Life Insurance
There are numerous life insurance policy options available, ranging from comprehensive whole life to limited-term policies. While term policies are typically the least expensive type of life insurance, whole life policies provide several advantages that policyholders may want to consider before purchasing.
These include a death benefit that is guaranteed, predictable premiums over time, and dividends that can provide cash or help offset the cost of life insurance over time.
What Are Dividends?
Many whole life insurance policies pay policyholders dividends that represent a portion of the insurance company's profits. These dividends are similar to traditional investment dividends in that they represent a portion of a public company's profit.
The amount of the dividend is frequently determined by the amount paid into the policy. For example, a $50,000 policy with a 3% dividend will pay a policyholder $1,500 per year. If the policyholder contributes another $2,000 in value during the following year, they will receive an additional $60, for a total of $1,560 the following year. These amounts can grow over time to cover some of the costs associated with premium payments.
Whole life insurance dividends can be guaranteed or non-guaranteed depending on the policy, so it's critical to read the fine print before purchasing a policy. Guaranteed dividend policies frequently have higher premiums to compensate for the added risk to the insurance company. Non-guaranteed dividends may have lower premiums, but there is a risk that no dividends will be paid in a given year.
Finally, when determining how sustainable dividends are in the future, policyholders should consider the insurance company's credit rating. Major credit agencies rate the majority of insurance companies A or better.
Using Policy Dividends
There are numerous ways to use whole life policy dividends, ranging from receiving a check in the mail to purchasing additional insurance. Dividends are most commonly used for the following purposes:
- Cash or check: A policyholder may request that the insurer send a check in the amount of the dividend.
- Premium deductions: To offset the cost, a policyholder may request that the dividend be applied to future premiums owed.
- Additional insurance: A policyholder can use the dividend money to buy more insurance or prepay their policy.
- Savings account: A policyholder may elect to keep the dividend in a savings account 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 are generally not taxed by the IRS because the insurance companies generated the gains from their policyholders. Dividends received from a life insurance policy are considered a distribution from the contract and are taxed in the same manner as other types of distributions. Dividends are distributed tax-free until the taxpayer's investment in the contract is depleted. (Dividends reduce the contract owner's investment.)
Because the insurance companies made money from their policyholders, dividend payments are essentially treated as refunds for overpayment of premiums. This means that taking the cash or check from dividends and reinvesting the proceeds in an investment vehicle that could earn more income is usually the best option.
Frequently Asked Questions
Does a Whole Life Insurance Policy Pay Dividends?
Yes. Whole life policies pay out dividends.
How Does Dividend Paying Whole Life Insurance Work?
There are several ways to receive dividends from whole life insurance, including a reduction in premiums, a check from your insurance company, or allowing it to remain in the savings component of your policy.
Can You Withdraw Dividends From Life Insurance?
Yes. Dividends from your life insurance policy can be withdrawn at any time.
Do I Have To Pay Taxes on Life Insurance Dividends?
Income tax does not apply to dividends from life insurance policies.
The Bottom Line
Many whole life insurance policies pay policyholders dividends that can be used in a variety of ways. Individuals should investigate how dividends are calculated and whether or not they are guaranteed when evaluating insurance policies, as well as how they intend to handle dividend income. Because of the favorable tax treatment, the best option is usually to take the cash and reinvest it elsewhere for a higher return.
Furthermore, because there is more to a good insurance policy than its dividend, make sure to read the entire policy to ensure that it is the best whole life insurance policy for your circumstances.