Whole Life Insurance: Dividend Option Or Not?

Whole life insurance is a form of permanent life insurance that stays in place for an individual's lifetime as long as premiums are paid. Whole life insurance policies offer a guaranteed death benefit, predictable premiums over time, and even dividends that can provide cash or help offset the cost of life insurance. Dividends are not guaranteed but are paid annually in most cases. They are based on the insurer's financial performance, such as interest rates, investment returns, and new policies sold. The dividends can be distributed as cash or used to purchase additional insurance or reduce premiums.

How are whole life insurance dividends paid out?

Dividends from whole life insurance policies are usually paid out annually and can be distributed in several ways. The most common methods include:

• Cash or check: The policyholder can request that the insurer send a check for the dividend amount or transfer the funds to their bank account. This option offers the most flexibility, as the money can be used for anything.
• Premium deductions: The policyholder can choose to put the dividend towards future premiums, reducing the amount they owe.
• Additional insurance: The policyholder can use the dividend to purchase additional insurance or prepay on their existing policy, increasing their death benefit without a corresponding premium increase.
• Savings account: The policyholder can leave the dividend with the insurance company, allowing it to earn interest. These funds can be withdrawn at any time or added to the death benefit.

It's important to note that dividends from whole life insurance policies are not guaranteed and depend on the insurer's financial performance. The amount of the dividend will also depend on the price of the premiums paid by the policyholder. Policyholders should carefully review the details of their plan, including whether dividends are guaranteed, and consider the insurance company's credit rating when evaluating how sustainable dividends are likely to be in the future.

What are the tax implications of whole life insurance dividends?

Dividends from participating whole life insurance policies are generally not subject to income tax. The Internal Revenue Service (IRS) considers these payments as a return of your unused premiums. However, there are certain situations in which you may have to pay taxes on your dividends.

Firstly, if you receive your dividends as a check and choose to reinvest the proceeds in an investment vehicle that could earn more income, this may be taxable. This is because the dividends are treated as refunds for overpayment of the premium, and so taking the cash may be the best option.

Secondly, if you leave your dividends in a savings account with the insurer to earn interest, the gains earned as interest may be taxable. Therefore, it may be more financially beneficial to take the dividends as cash and reinvest them elsewhere.

Thirdly, depending on how you make withdrawals, you could owe taxes if you receive more than the total amount of premium payments you've made into a life insurance policy. This is because the dividend payments are treated as distributions from the contract, and they are taxed similarly to other types of distributions. Dividends are distributed income-tax-free until the taxpayer's investment in the contract has been reduced to zero.

Finally, some life insurance plans have different taxable measures of income when they are paid out, so it is important to understand your policy and consult a tax professional to avoid excess taxes.

How do whole life insurance dividends differ from interest or annuities?

Dividends from whole life insurance policies are based on the performance of the company's financials, including interest rates, investment returns, and new policies sold. In contrast, interest rates on annuities or other investments are typically fixed and guaranteed. Whole life insurance dividends are also not guaranteed, while interest payments on annuities or other investments are usually guaranteed.

Whole life insurance dividends are treated as a return of premium or overpayment of premium by the Internal Revenue Service (IRS) and are therefore not subject to income tax. On the other hand, interest earned on annuities or other investments is typically subject to income tax.

Whole life insurance dividends can be used in several ways, such as receiving them as cash, reducing future premiums, purchasing additional insurance, or leaving them with the insurance company to earn interest. In contrast, interest earned on annuities or other investments is usually paid out as cash, although it may also be reinvested or used to purchase additional investments.

Whole life insurance dividends may be guaranteed or non-guaranteed, depending on the policy. Non-guaranteed dividends may be lower, but there is a risk that no dividends will be paid in a given year. In contrast, interest rates on annuities or other investments are typically guaranteed and fixed.

When choosing between whole life insurance dividends and interest or annuities, it is important to consider the level of risk and return, tax implications, liquidity needs, and the overall financial goals and circumstances.

How do insurance companies determine dividend amounts?

Dividends from whole life insurance policies are based on the performance of the company's financials, including interest rates, investment returns, and new policies sold. The amount of a dividend is also tied to the price of premiums paid by the policyholder. The higher the dividend, the more expensive the policy.

Dividends are not guaranteed and depend on the insurer's financial performance. They are most common among mutual insurers, as publicly-traded insurance companies often pay dividends to their shareholders instead of policyholders.

When determining dividend amounts, insurance companies consider the following factors:

• Mortality (death claims): The actual death claims experience is compared with the insurance company's estimates when issuing policies and pricing premiums.
• Expenses: The difference between the actual expenses incurred and the expected expenses when setting the premiums.
• Investment performance: The difference between the actual investment returns and the guaranteed interest rates required to meet contractual obligations.

The dividend amount often depends on the amount paid into the policy. For example, a policy worth $50,000 that offers a 3% dividend will pay a policyholder $1,500 for the year. If the policyholder contributes an additional $2,000 in value during the subsequent year, they will receive $60 more for a total of $1,560. These amounts can increase over time and may eventually offset some costs associated with premium payments.

What are the pros and cons of dividend-paying whole life insurance?

Dividend-paying whole life insurance is a type of permanent life insurance policy that offers a death benefit and the potential to receive dividends from the insurance company's profits. These dividends are not guaranteed and depend on the insurer's financial performance. Here are some of the pros and cons of dividend-paying whole life insurance:

Pros:

• Income stream: Participating whole life insurance policies can help create an additional stream of income. These plans pay annual dividends whenever the life insurance company performs well financially.
• Increased death benefit: Dividend-paying whole life insurance policies allow you to increase your death benefit while paying the same premium. This is because you can use the annual dividends to buy additional insurance coverage.
• Accumulated cash value: Like regular whole life insurance plans, dividend-paying whole life insurance policies accumulate cash value over time. However, with these policies, the potential to accumulate wealth is greater since you have the option to buy additional paid-up coverage.
• Guaranteed cash value: Dividend-paying whole life insurance offers a guaranteed cash value that accumulates over time, providing a stable source of funds that policyholders can borrow against when needed.
• Tax-free dividends: Dividends from dividend-paying whole life insurance policies are often not subject to federal income taxes. They are treated as a return of premium by the life insurance company and are considered a refund of excess premium payments.

Cons:

• Higher premiums: One of the most significant disadvantages of dividend-paying whole life insurance is the higher premiums associated with guaranteed dividend policies compared to non-guaranteed alternatives. This can make it more expensive to maintain coverage over the long term.
• Limited growth potential: The growth potential of cash value within these policies is typically limited compared to other investment options like stocks or mutual funds.
• Non-guaranteed dividends: Dividends are not guaranteed with dividend-paying whole life insurance policies. There is a risk that non-guaranteed policies may not consistently pay dividends, depending on the insurer's financial performance and market conditions.

Frequently asked questions