What is a Dividend?
A dividend is a sum of money that a company periodically pays out to the appropriate parties if the company was profitable during the applicable window of time. Life insurance companies may pay permanent life insurance policy owners dividends, for example.
The most common instance in which dividends are paid applies to companies with shareholders. When the company has a profitable period of time (e.g., a quarter or year), they pay their shareholders a portion of their retained earnings proportional to the individual’s share in the company.
But you don’t need to buy stock to earn dividends. You can also get them by buying specific kinds of life insurance.
Life insurance and dividends
Term life insurance policies do not pay dividends. If you want a life insurance policy with dividends, you’ll need to purchase a whole life insurance policy. Options vary between insurers and policies.
When you get your life insurance dividend, you have options. You can usually:
- Add it to your policy’s cash value, which also purchases more death benefit (this is the default option).
- Use it to pay premiums
- Withdraw it as cash
Good news: in the eyes of the IRS and state tax authorities, dividends are usually seen as a return of premium. That means they aren’t subject to income taxes even if they are withdrawn from the policy, until they exceed your basis.
How life insurance companies calculate dividends
While dividends are not guaranteed and the dividend rate distributed to you depends on the life insurance company’s performance over the considered time period, reputable insurance carriers haven’t missed a year paying dividends in at least the past century.
You might get a dividend if:
- The company paid out less in death benefits over than time period than expected
- They saw positive returns on their investments
- Market interest rates were favorable
In short, the dividend you get represents a specific share of the insurer’s profit.
Most permanent life insurance policies distribute dividends as a percentage (e.g., 3%) of the policy’s cash value. If you take out a loan against the cash value, your insurance company may or may not factor in the loan amount when calculating your dividend rate for the specified time period. This is also known as direct recognition and non-direct recognition.