How Are Dividends Credited to Whole Life Policies?

Two women hold their newborn baby while considering whether they need life insurance
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Life insurance dividends are additional earnings that may be available from certain whole life policies. Those payments can be useful in a number of ways, and you typically have several choices for managing dividends from your policy.

We’ll review the most popular dividend payment options and explain when dividends are available from a life insurance policy. You’ll also learn how to choose the best dividend option for you and your loved ones.

Key Takeaways

  • Dividends are payments from a life insurance company to holders of participating whole life policies. 
  • There’s no guarantee that you’ll receive dividends in any given year, and the payment amounts can change.
  • You can generally choose to use dividends to increase your coverage or lower your premiums, or you can opt to receive cash. 
  • You can typically change how you prefer to receive dividends as your needs evolve.

What Are Dividends?

Dividends are payments from a life insurance company that represent a return of your premium payments. Depending on the options offered by your insurer, you may be able to use dividends to buy additional life insurance coverage or reduce your premium payments. You may also be able to request that dividends be paid out in cash.

To receive a life insurance dividend, you need to have a “participating” whole life insurance policy. This type of coverage is offered by mutual life insurance companies and allows policyholders to benefit from an insurer’s strong financial performance, but it may be more expensive than a nonparticipating policy. 

But dividends are not guaranteed, and insurers are not required to pay dividends in any given year. Insurance companies only pay dividends if it makes sense for them financially.

There’s no way to know if you will receive life insurance dividends, and the amount can change each year. As a result, it’s best to appreciate dividends as a bonus instead of relying on them for income or to increase coverage.

When and How Are Dividends Paid?

Dividends are typically paid annually. If you’re eligible for dividends, you can choose how to use them.

Receive Cash

The simplest option is to take dividends in cash. Your insurer will simply send you a check, and you can use the money in any way you want. But if your goal is to maximize your life insurance coverage, other dividend options may make more sense.

Buy Paid-Up Additional Insurance

Paid-up insurance is life insurance that does not require additional premium payments. When you choose this option, your dividends buy you additional insurance—including a bigger death benefit—that does not require future payments. That insurance also has a cash value and can potentially generate additional dividends.

Reduce Premiums

If you’d prefer to minimize your out-of-pocket expenses for life insurance, you can choose to apply dividends to your premiums. For example, if your annual premium is $1,000 and you get a $150 dividend, you could apply it to your premium and pay only $850 out of pocket. 

If you plan to use dividends to reduce premiums, it may make sense to select an annual premium payment. Paying monthly or quarterly could mean the premium that coincides with your dividend payment is smaller than the dividend payout. If your dividend exceeds your premium, you can choose a secondary option for the remainder of the dividend (such as being paid in cash).

Repay Outstanding Loans

If you have a loan balance on your policy, you can apply your dividends to reduce it. Be sure to monitor your loan carefully, and plan to make payments even if you do not receive dividends, since they’re not guaranteed and the amount may vary from year to year.

Earn Interest

If you don’t need the money immediately, you can ask the insurance company to hold your dividend payments in an interest-bearing account. The funds are not part of your insurance contract, so they don’t affect your death benefit, cash value, or premiums. But the money is available whenever you decide to withdraw it.

Any interest you earn is typically treated as taxable income, so you’ll need to track and report your earnings each year.

You can usually change your dividend payment option from year to year, but ask your insurer for details.

How Are Dividends Determined?

Insurers can choose to pay dividends when their investments and insurance policies perform well financially in a given year. The amount you might receive depends primarily on your cash value and the current dividend interest rate the insurer credits to cash values. For example, if you have a qualifying cash value of $10,000 and the crediting rate is 5%, you would receive $500 in dividends for the year.

Are Dividends Taxed?

Dividends are generally treated as a return of your premium payments, and as such are often tax-free until the amount you receive exceeds the amount you paid into a policy. But it’s critical to review your policy with a CPA and insurance expert to make sure you’re aware of your tax situation.

Dividend payments reduce your basis in the insurance contract, which is generally the amount you’ve paid in premiums. If you surrender or cash out a policy with no (or a low) remaining basis, the money you receive may be treated as taxable income.

If your policy is a modified endowment contract (MEC), the rules quickly become complicated and it’s more likely that dividends will be taxable.

How to Find the Best Dividend-Paying Whole Life Policy

When shopping for life insurance, the first step is determining what type of coverage you need, and how much. If you choose a dividend-paying whole life insurance policy, select an insurer with a strong financial profile. Insurance company rating services like A.M. Best, Standard & Poor’s, and Fitch can help you identify companies that are on solid financial ground and therefore likely able to meet financial commitments like paying out insurance benefits.

It may also help to review a company’s history of paying dividends—although there’s never a guarantee that you’ll receive dividends, even from a company with a long track record of paying them. For example, MassMutual has paid dividends every year since 1869, and New York Life has paid dividends annually since 1854. Researchers at The Balance keep a list of the best whole life insurance companies, and the criteria include the company’s history with dividends.