What Are The Dividend Options In Life Insurance?

A Quick Overview of Dividends

Definition

In its simplest form, a dividend is money paid from your life insurance company to you. Often this means that you have a whole life insurance policy that pays dividends, also referred to as a participating policy contract. When it comes to dividends, purchasing a participating policy contract with a company is like investing in that company. When that company is profitable, it rewards your investment by paying you dividends. It’s important to note that this is only available for participating life insurance policies. Dividend options are how you choose to receive this money.

Dividends

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What type of life insurance policy is eligible to earn dividends?

Term Insurance

Participating Whole Life Insurance

Universal Life Insurance

Whole Life Insurance

Participating Whole Life Insurance Policies are the only type of policy that can earn dividends. Purchasing a participating policy contract is like investing in the insurance company. When the insurance company makes a profit, they share these profits with their participating policy holders.

Participating Whole Life Insurance Policies are the only type of policy that can earn dividends. Purchasing a participating policy contract is like investing in the insurance company. When the insurance company makes a profit, they share these profits with their participating policy holders.

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What is dividend amount based on?

The amount of death benefit owned

Net worth, Credit score and Driving record

Human Life Value

The amount of paid-up insurance in the policy will determine how much dividend the policy can earn. The older a whole life policy gets the more paid-up insurance it will have which increases the amount of dividend that can be earned.

The amount of paid-up insurance in the policy will determine how much dividend the policy can earn. The older a whole life policy gets the more paid-up insurance it will have which increases the amount of dividend that can be earned.

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Are dividends guaranteed?

Yes

No

Similar to an investment, dividends are NOT guaranteed. However, once a dividend has been paid it cannot be taken away.

Similar to an investment, dividends are NOT guaranteed. However, once a dividend has been paid it cannot be taken away.

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Every year the insurance company sends a dividend check to Robert. What dividend option does Robert have on his policy?

Cash Payment

Paid-Up Additions

Premium

Interest

Term Insurance

The Cash Payment dividend option is exactly what it sounds like: A Cash Payment from the insurance company. These Cash Payments are not taxable until you receive a greater amount in dividends than what you have paid in premiums.

Example: You have paid $50,000 in premiums. You can earn $50,000 in dividends tax free. Any dividend amount above $50,000 becomes taxable when received as a Cash Payment.

The Cash Payment dividend option is exactly what it sounds like: A Cash Payment from the insurance company. These Cash Payments are not taxable until you receive a greater amount in dividends than what you have paid in premiums.

Example: You have paid $50,000 in premiums. You can earn $50,000 in dividends tax free. Any dividend amount above $50,000 becomes taxable when received as a Cash Payment.

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The insurance company uses your dividend to buy extra insurance in your policy. What dividend option is on your policy?

Premium

Term Insurance

Paid-Up Additions

Cash Payment

Interest

With the Paid-Up Additions dividend option, the insurance company will use your dividend to purchase additional insurance at the age your policy was issued.

Since insurance gets more expensive the older you get, this is a special feature which allows you to purchase additional insurance at a younger, less expensive age. This increases both your cash value and death benefit and makes you eligible to earn even more dividends.

Of all the dividend options available, this one can create the most long-term value. It's our favorite!

With the Paid-Up Additions dividend option, the insurance company will use your dividend to purchase additional insurance at the age your policy was issued.

Since insurance gets more expensive the older you get, this is a special feature which allows you to purchase additional insurance at a younger, less expensive age. This increases both your cash value and death benefit and makes you eligible to earn even more dividends.

Of all the dividend options available, this one can create the most long-term value. It's our favorite!

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Dividend Options are:

Selected when the policy is issued. They are a part of policy design and cannot be changed.

Can be changed by the policy owner at any time

Are chosen by the insurance company once a year

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Are Dividends taxable?

No, as long as they do not exceed total premiums paid

Yes, since they are income from investments

Since dividends are considered a refund of premium, they are not taxable. Unless the dividends become greater than total amount of premiums paid, and then they would become taxable.

Since dividends are considered a refund of premium, they are not taxable. Unless the dividends become greater than total amount of premiums paid, and then they would become taxable.

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Fluctuation

Similar to an investment, dividends are not fixed ahead of time. As the company does well or poorly, the amount you receive via dividends will vary. Companies cannot guarantee a dividend in advance, but once a dividend has been paid, it cannot be taken away. Dividends can be different for each company. Because of this, it’s important to do your research on the company’s dividend-paying history. Some dividends are dependent on your policy loan status, meaning with an outstanding loan, you could earn less dividend. How dividends are paid is determined by the direct and non-direct recognition policy status.

Taxes

For a policy with dividends included, you are often paying a higher premium. Because of this, the tax world considers that dividends are a return of premium. Therefore, if you are receiving dividends through a participating whole life policy, most dividend options are tax-deferred. This is the number one thing to take away about life insurance dividends.

The Four Life Insurance Dividend Options

So what are dividend options? Life insurance dividend options are the different ways you can elect to receive your dividend. All of the following are dividend options except the fifth. 

1. Cash Payment
2. Paid-Up Additions
3. Premium
4. Interest
5. Term Insurance

Applying your dividend toward paying for term insurance is becoming more popular, but it isn’t one of the classic dividend options.

Let’s get into how these dividend options work, as well as their pros and cons.

Receiving Your Dividend as a Cash Payment

This dividend option is exactly what it sounds like. Yearly, your insurance company will write you a check for the dividend. Then, you can use the cash however you’d like. Like we mentioned earlier, dividends are seen as a premium refund. When receiving them as cash, they aren’t taxable until/unless they exceed premiums paid for a policy (cost basis). 

For instance, let’s say you paid premiums on a whole life insurance policy for 15 years and your cost basis is now $70,000. Then, you opt for dividends in the form of cash payments. The day you receive a total of $70,000 in cash dividends, your dividends received in cash become taxable income going forward. Also, once dividends meet the cost basis (the process described above), anything else withdrawn from the policy is also taxable. 

Putting Your Dividend Toward Paid-Up Additions

Paid-up additions (PUAs) are like adding to the value of your original policy and may increase the cash value significantly over time. When you choose this option, you opt for your insurance company to use your dividend money to purchase paid-up additions. We recommend our clients elect to purchase paid-up additions as their option because it allows their dividend to create the most long-term value. 

As you acquire more PUAs, both your cash value and your death benefit increase. As your death benefit increases, you become eligible for more dividends. Of all the dividend options available, we recommend this option because of these benefits.

Putting Your Dividend Toward Your Premium

This life insurance dividend option is fairly straightforward. When chosen, your insurance company will simply use your dividend to pay some or all of your yearly premium. If you choose this option, you might also need to choose a secondary option if your dividend is larger than your premium. On the other hand, if your dividend is less than your premium, you’ll need to pay the rest as you normally do. 

When you opt for using your dividend toward your premium payment, you must start paying your premium annually. For instance, if your annual premium is $8,000 and your dividend that year is $1,500, you would still need to pay the remaining $6,500 all at once. Since dividends fluctuate, you might be paying more or less of your premium each year.

Leaving Your Dividend in an Account to Accrue Interest

This option creates an account for your dividends that includes interest. This account is exclusive only to dividend payments, meaning you can’t choose to add other funds if the interest rate is good or for some other reason. You can, however, keep the funds in the account for however long you wish and withdraw the funds at any point in time to use. The negative is that the account does not benefit from the other tax-exempt dividend options. While your dividends themselves are not seen as taxable income as we mentioned earlier, any interest accumulated is and will be taxed on a yearly basis regardless of whether or not the funds were withdrawn.

Use Your Dividend to Purchase Term Insurance

Finally, this life insurance dividend option has emerged rather recently allowing you to pay for term insurance with your dividends. This option is the most efficient (short-term) for a significant death benefit. If your dividend exceeds the cost of the term insurance, you’ll need to choose a secondary option as well.

Where to Go from Here

After all this talk about life insurance dividend options, you might want to understand even more about them. This video explores if dividends are all they’re cracked up to be, and you can always schedule a complimentary strategy session to see a life insurance illustration with illustrated dividends.

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