Life Insurance Dividends Explained

life insurance dividends

With so many types of life insurance policies available, it can get confusing trying to find the best coverage option available. Do you go with term life or whole life and what are the best life insurance companies for them? To start, term is usually the least expensive, but whole life is provides many advantages too. Whole life insurance can provide you level premiums, a guaranteed death benefit, and dividends to help you in a variety of ways.

Today, we’re going to go over some important considerations for shoppers looking into policies with dividends. We’ll also answer some frequently asked questions such as: 

  • What are Life Insurance Dividends? 
  • How are life insurance policy dividends taxed? 
  • How does dividend paying whole life insurance work? 

What are Dividends in Life Insurance?

Life insurance dividends definition: A dividend is a payout from the annual surpluses of the life insurance company. It’s a portion of the carrier’s profits. 

Some whole life insurance policies provide policy owners dividends and some do not. These dividend payouts are a great thing. However, you need to know your options, how life insurance dividends work and who offers them.

Mutual Life Insurance Companies Pay Dividends

Not all life insurance companies pay dividends. Not all whole life insurance policies pay dividends. So who pays and what is the source of life insurance policy dividends?

Only mutual life insurance companies will pay out a dividend to the policy owners. Mutual companies are life insurance companies that are owned by the policyholders. Stock companies are owned by shareholders.

When it comes to whole life insurance dividends, you have several options on how you can use them. 

Popular Dividend Options

Let’s first look into the most popular dividend options that policy holders can choose from.

1. Policy Loan Repayment

With some life insurance companies you can choose to use your dividends to pay the principal or interest of your policy loans. This is structured by paying the loans first before any of the dividend options below are implemented.

2. Cash Payment

You can choose to get your life insurance policy dividend via cash payment. This is similar to the dividends you’d receive from stocks. When you choose this option, the life insurance company will typically pay your dividends in the beginning of the end of the 1st or 2nd policy year. Your dividends will be treated as tax free return of premiums.

3. Paid Up Additions

You may use your dividends to buy paid up additions. Paid up additions insurance is additional life insurance coverage of the same type that a policyholder buys, using the life insurance policy’s dividends. Your paid-up additions also earn dividends, and their value will continue to compound over the life of the policy.

4. Buy 1 Year Term

You can use the dividends on life insurance to buy additional 1 year term policies (as much as possible and permitted based on your age). You will not need to provide evidence of insurability, but you may be limited to the amount of coverage. Every company is different, so the limitations may vary.

5. Accumulate Interest

Life insurance policy owner’s may opt to keep the dividends with the life insurance company to earn and accumulate interest. The policy’s payable interest rate on your accumulated account has guarantees. It is guaranteed to be equal or surpass the stated minimum. At anytime, you may still withdraw cash from your dividend accumulation account. If you were to die or you want to surrender your policy- your policy will pay the face amount or the cash surrender value (as well as the value of the accumulated account). Be aware that the interest that is earned on the accumulated dividends is taxable once you have the right to withdraw them. This is true even when the owner does not choose to withdraw them.

6. Reduce Future Premiums

As the policy owner, you can select to have your life insurance company apply your dividends to decrease future life insurance premiums. As time goes on and your dividends increase, your premium payments will go down. What if your dividend paying whole life insurance company’s investment portfolio exceeds expectations? Your dividends may even equal or go over the cost of your premiums!

Are Life Insurance Dividends Taxable?

How are life insurance dividends taxed? The dividends you earn from your participating whole life insurance policy are not taxed by the IRS.  Why are the dividends not taxed as income?

The simple answer is that your life insurance dividends aren’t like traditional “dividends.”  Dividends on life insurance policies are not like dividends from a mutual fund or stock. 

The life insurance dividends are a portion of the insurer’s profits- the company’s profits were made from your premiums. So the IRS looks at these profits like they’re a refund or return of premium. Technically, it isn’t a return of premium. It’s a return of the excess life insurance premium and that is why it isn’t taxed. Basically, your life insurance carrier gets all of the life insurance premiums from the policy holders and invests them. If their expenses and mortality is favorable, the carrier will declare a dividend.

>>Related: Is life insurance taxed?

Life Insurance Dividends

Hopefully this article provided you the information you need about dividend options for whole life insurance. The bottom line is that the price for a participating whole life insurance policy is typically higher compared to a non-participating policy. If your goal is to get coverage at the lowest price possible, then shop for a cheap term life insurance policy.  Term life will be less expensive than both participating and non-participating whole life. 

Please contact us if you have questions about your life insurance policy or your dividends. We’d be happy to help you. Life Insurance Blog is an independent life insurance broker. This means we have access to more than one company. In fact, you’ll get quotes and access to over 60 of the best life insurance companies in the marketplace.

Want to learn more about whole life and cash value? Make sure to read our best cash value whole life insurance companies review. 

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Michael Quinn

Michael Quinn

Michael is owner & life insurance expert at Life Insurance Blog where we've helped thousands of shoppers learn and secure affordable life insurance online.
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Simple way to compare and buy life insurance

The Simple way to compare and buy life insurance