Whole life insurance has many benefits, but dividends are undoubtedly one of the best. Dividends are an annual payment that policyholders receive from a participating life insurance policy. The amount you receive depends on how much coverage you have and on the company’s revenue, operating expenses, and rate of investment returns. Essentially, dividends from whole life insurance are like an annual bonus you get just for owning a policy.
Whole life insurance is a type of permanent life insurance, a category of life insurance characterized by death benefit coverage for your entire lifetime and a cash value component that can act as an investment vehicle. There are several types of permanent life insurance, including universal, indexed universal, and variable universal, but whole is considered the most popular.
Term life insurance is a different type of life insurance that offers coverage for a specific number of years, or “term.” Unlike permanent life insurance, term doesn’t have a cash value component — it’s known as “pure life insurance” since it offers only death benefit coverage in return for paying premiums (and because of that it is considerably less expensive than hole policies).
The type of life insurance policy you choose depends entirely on your personal health, financial, and family situations.
Features of whole life insurance include:
- A death benefit, which is paid out to your listed beneficiaries upon your death.
- No expiration date, so the policy lasts your entire lifetime, as long as you pay the premiums.
- Fixed premiums that don’t change over the course of the policy.
- A cash value component, which accumulates every time you pay a premium. The cash value can be used to pay your life insurance premiums, can be borrowed against, or can be partially withdrawn during your lifetime.
- Dividends, offered by some whole life insurance policies, which are annual payments that the insurance company makes to policyholders.
What Are Life Insurance Dividends?
Life insurance dividends are regular payments (usually annual) that insurance companies make to policyholders who have participating policies. Where do the funds for these payments come from? Dividends are the excess profits of the insurance company after their projected costs and claims have been covered. Instead of pocketing the excess, insurers pay it out to policyholders as an additional benefit of owning the policy.
Whole life insurance dividends are similar to the returns you would receive from a typical investment, but they come with a major additional benefit: the IRS treats them as a return of unused premiums — and as such, you don’t have to pay income tax on them!
The amount you receive in dividends depends on:
- The size of your policy (the higher your coverage amount, the more dividends you are eligible to receive).
- The insurer’s revenue, investment returns, interest rates, operating expenses, and paid claims.
After the insurer calculates all of the above factors, it then determines how much (if any) dividends are due to each policyholder.
Not all insurers or whole policies offer dividends, so it’s important to check this out when buying life insurance. Additionally, some companies offer guaranteed dividends, while others offer non-guaranteed dividends. Sometimes, policies with guaranteed dividends charge higher premiums than those with non-guaranteed premiums. In this way, insurance companies cover their risk in case they don’t actually have a surplus.
What Life Insurance Policies Pay Dividends?
Permanent life insurance policies, including whole, may pay out dividends, though not all do. The option, however, is there. With term policies, there is no such option.
Insurers that are most likely to offer policies with dividends are mutual insurance companies, which are essentially owned by policyholders. (Have you noticed that many insurance companies have the word “mutual” as part of their name? It’s not a coincidence — the term “mutual” is simply a description of the type of company it is).
Mutual companies aren’t publicly traded, and their goal is to provide life insurance coverage at or near cost. These companies invest in relatively safe, low-yield funds and profits are paid out to policyholders in the form of dividends.
Mutual companies are starkly different from publicly traded life insurance companies. The latter has a responsibility first and foremost to their shareholders. Any excess profits they have first go to them, and only afterward to policyholders.
As a consumer, a mutual life insurance company is a better way to get dividends. The main downside of mutual companies is that you may have a hard time determining how solid the company is or how it calculates the dividends due to each policyholder.
What is a Dividend-Paying Whole Life Insurance Policy?
A dividend-paying whole life insurance policy is a life insurance policy that pays out dividends. While mutual companies are most likely to offer this option, publicly traded companies may do so also.
If you decide that whole life insurance is the right move for you and your family and you’d like to receive the added benefit of dividends, it’s essential to choose an insurer and policy that offers this option. In other words, read the fine print of every policy and don’t commit to anything until you’re sure that the policy is exactly what you want.
We rounded up some of the best whole life insurance companies here, and you can see which ones have the option of paying out dividends.
Do you have to pay taxes on life insurance dividends?
In most cases, life insurance dividends are not taxable. Only when choosing the cash, or interest-earning side account are there immediate taxable implications. If the dividends are put back into the policy as paid-up additions, often taxes will never have to be paid on them.
Life Insurance is protected by IRS code 7702 and the monies which grow inside of a policy are tax-deferred, with the possibility of being tax-free as well.
There are a few scenarios where insurance dividends are taxable.
- If you choose the “Cash” option for dividends. Once the amount of dividends received is more than the total premiums paid you may be taxed.
- The “Interest-Earning Account” dividend option will also trigger taxes on all future interest earned, albeit not on the original principal of dividends deposited if no withdrawals are made.
- Upon surrender of a policy, the amount of money above total premiums paid, both from guaranteed cash value growth and dividends, is taxable.
In a scenario when the life insurance dividends are taxable. The following is the answer to the question of “how are life insurance dividends taxed?”
When applicable, Life insurance dividends tax is the same as any other taxable life insurance withdrawals, in that they are taxed at ordinary income levels in the year of the withdrawal.
Dividend Payout Options — What Can Life Insurance Dividends Be Used For?
Dividends are a great benefit of whole life insurance, and what’s more, you can choose to receive them in different ways.
There are 4 main ways you can receive or use life insurance dividends:
- Cash – You can request to receive the dividends as cash and the insurer will send you a check or make a direct deposit to your bank account.
- Pay life insurance premiums – You can use the dividends to pay for future premiums so that you don’t have to pay any cash out of pocket.
- Save and earn interest – You can ask the insurance company to hold the dividends for you so you can earn interest on them.
- More life insurance – Known as Paid-Up Additions (PUA), this is the default choice for dividends unless you choose otherwise. PUA allows you to reinvest the dividends back into the policy. Practically, this means that every time you are due payment of dividends, you purchase a small whole life insurance policy that gets attached to your base policy. You pay all the premiums upfront with the dividends. The rest of the dividends get placed into a cash-value account. The next time dividends are due, you receive them for your base policy and all the additional policies you have, and your death benefit and cash value can grow at a compounded rate.
What are the best dividend-paying whole life insurance companies?
Below is a chart showing the historical dividend interest rates of some of the top insurance companies in the market.
It should be noted that not all companies calculate their dividend interest rates the same, so the simple dividend interest number may not be a good enough factor to decide which policy to purchase. Another point is that past performance does not necessarily indicate how the future will play out. However, all we have is the past and the present and are unable to know the future with certainty. Therefore, the best way to compare companies is by getting illustrations with the exact same specifications and then comparing them apples to apples.
Historical Whole Life Insurance Dividend Interest Rates
|New York Life||5.80||6.10||6.00||6.10||6.30||6.20||6.20||6.00||5.90||5.80||6.11|
We used these specifications:
- 30-year-old Male
- Preferred Plus (Best health class)
- $1,000,000 initial death benefit
- Premiums paid to age 100
This depicts an annual premium of $10,530. (Which is Guardians base premium. MassMutual only required $9,610 so the remaining $920 was added as Paid-up Additions).
While the business of dividends may seem slightly complicated, they are a very worthwhile benefit of whole life insurance. If you need help determining which dividend-paying whole life insurance is right for you, Sproutt insurance advisors can offer expert guidance and assistance.