Did you know you could be paid dividends on your life insurance policy?
When it comes to purchasing life insurance, there is no shortage of factors to consider in your decision.
While purchasing term life insurance over whole life insurance is a clearly preferable choice for most people, whole life insurance comes with a number of unique benefits.
Life insurance dividends, also known as a return of excess premium, are one of them.
In this post, we’ll walk through how life insurance dividends work and how they can benefit you.
What Are Life Insurance Dividends?
Life insurance dividends are paid out to participating life policies when insurance companies earn excess profits after claims and operating costs are covered.
Life insurance dividends actually bear a close resemblance to the dividends you would receive from any other type of investment, where you share in the returns of the company you invested in.
Whether or not your policy pays out dividends will depend on a number of factors, the first of which is the type of life insurance it is.
Participating life insurance policies are usually whole life policies that pay dividends, but permanent coverage can be participating or non-participating.
Dividends are determined differently for privately held (stock) and mutual companies, and policyholders have a number of options on how to use their life insurance dividends.
Finally, dividend amounts change each year and are not guaranteed, but dividend-paying whole life insurance policies charge higher premiums.
How much money you earn in dividends depends on how much you pay into your policy.
While premiums can get pretty costly with a participating policy, the dividend amount can grow over time, alleviating some of the weight of your premium costs.
Life Insurance Dividends & Payouts
Your dividend is paid out on the annual policy anniversary (the date it was purchased) the year after which the dividend is earned.
While that is a set standard across life insurance companies, the way you receive your dividends is up to you.
Participating policy dividends can be paid out in 4 main ways, and you have the choice to pick which method makes the most sense for you.
- Cash – the insurance company sends you a check for the dividend amount.
- Premium Payments – your dividend can cover and pay up your premium payments.
- Savings – dividends may be deposited in your policy’s cash value and allowed to earn interest.
- Buy More Insurance – dividends may be used to buy paid-up coverage.
You can use your own financial goals to determine which type of payout to opt for.
If saving money for the future is your overall goal, then you could use your money to pay your premiums, offsetting the cost or covering it all together, or buy even more insurance.
If you have no need for the money today and wish for the dividend payment to benefit your loved ones later, you could add the dividend to your policy’s cash value, letting it accumulate interest alongside those funds.
Or maybe you could benefit from the cash now. If so, receiving your dividends via check could be the most viable choice for you.
Let’s take a look at a specific scenario to gain a deeper understanding of how this dividend payment could play out:
Since your dividend is usually calculated as a percentage of your current cash value, it is important to note that outstanding loans and withdrawals using your cash value as collateral will reduce payments.
If your current cash value is $50,000 and the dividend yield is 3.5%, your payout will be $1,750.
However, if your previous cash value was $50,000 and you’ve recently requested a $25,000 low-interest loan, your earnings will be $875.
Note: if you consistently re-invest your dividends into the cash value, your distributions will grow year-over-year.
The growth of your returns can be considerable after 10, 15 or 20 years.
What is a Participating Policy?
When you sign on for a life insurance policy, both you and the life insurance provider are entering into a mutually agreed upon contract.
As such, the company is expected to maintain its obligation as dictated in your policy.
That is why it is critical that you do your research before selecting a life insurance company and policy.
Just because a policy is whole life does not mean it is guaranteed to pay dividends.
Reading the policy carefully is key to ensuring you understand the terms of your plan’s coverage and its potential benefits.
Likewise, you should remember that this investment, like most, does not guarantee a return.
Your life insurance provider may end up with a substantial surplus one year and none the next.
If you’re buying a whole life policy because of the certainty that comes with it, you’ll be in excellent shape in terms of the cash value and death benefit you receive. You shouldn’t, however, depend on dividend returns with the same amount of certainty.
A participating policy is just that, one which participates in providing dividends, not one that guarantees them.
Private vs. Mutual Life Insurance Companies
At this point, you may be wondering how a company’s performance impacts dividends.
First, you should understand that mutual life insurance companies are owned by their policyholders.
Insurance premiums are calculated to cover operating expenses, claims, and unforeseen costs.
If there are surplus profits at the end of the fiscal year, a dividend is declared and is split between policyholders with participating whole life insurance policies.
With stock or private life insurance companies, participating policies offer a benefit similar to holding stock in the company.
If the company’s investments do well and the stock price rises, a dividend is declared and shareholders and participating policyholders share in the profits.
If the company’s stock falls, shareholders lose money but eligible policyholders do not lose their investment – they simply do not receive a dividend that year.
If life insurance dividends are used to pre-pay premiums, added to the cash value or used to buy paid-up additions to your whole life insurance policy, dividends are not subject to income tax because distributions are not made directly to you.
If the amount of the dividend is less than your insurance premiums for the year, dividends are considered a return of premium and are not taxable.
The IRS essentially treats the dividend as a refund for over-payment of premiums through the year.
In the event that the dividend exceeds the yearly premium, the amount in excess of the premium is taxable as income as a life insurance tax.
So, if you paid $1,500 in premiums and your dividend balance is $2,000, the $500 difference is taxable income.
Participating Life Insurance in Financial Planning
If dividend-paying whole life insurance is a part of your financial plan, you should thoroughly research and find the best life insurance company that fits your needs.
The company should be financially-stable (minimum “A” rating) with a history of paying dividends regularly.
Since interest earned on your cash value is tax-deferred until it is withdrawn, a participating policy can have significant tax advantages for some families.
In the end, there are many pros and cons of participating whole life policies.
Before buying coverage, make sure you review your financial needs and investment options before deciding if life insurance dividends are essential to your financial plan.