Are Life Insurance Dividends Taxable? A Guide To Understand

In the world of investing, many people are looking for a good option to “save money” and dividend-paying such as insurance comes into play. Now a big question is; are life insurance dividends taxable?

There’s a lot to understand about life insurance dividends today, so, we are going to share you our best review about it, starting from understanding what a dividend actually is to the common option of life insurance dividends and finally the answer of whether the life insurance dividends are taxable or not.

What Is A Dividend?

A dividend is a portion of the premium’s returns that are paid to your policy. A dividend must be paid when we are participating life policies to enhance the value. Dividends are considered a return of your premium no matter whether you receive them in cash or not. Or, you can earn dividends and leave them as an investment through the insurance company.

Easy to understand, insurance companies usually share profit with the participating policy holders through a dividend. This dividend is generated each year around the end of the year. Though you have been familiar with this, you may still need to learn completely about it including how they work, what companies are required to pay dividends, whether they are taxable, the dividends options availability and etc.

Essentially, we’ll try to answer; are life insurance dividends taxable?

What Companies Should Pay Life Insurance Dividends?

Dividend-paying life insurance is mostly an entire life insurance from a mutual company like MassMutual or New York Life, Guardian and some others which are better known as mutual insurance companies. Mutual companies are different from stock companies possessed by the policy holders rather than the shareholders of the stocks companies.

Whole life insurance which pays dividends is also popularly known as “participating life insurance” or “participating policy contract”. This means that the policy owners do participate in sharing in the insurance company’s profit.

Note, term life insurance and universal life insurance as well as the variable life insurance are not required to pay dividends as they are purchased from a mutual company which is not listed in a participating policy.

The Difference of Life Insurance Dividends and Other Dividends

Many people are confused of understanding the word “dividends” as it is almost used related with the public company that pays a stock dividend. If you have had a stock in a company paying dividend, you will likely receive a quarterly check out of the company.

Stock dividends could come in terms of extra shares rather than cash. Dividends represent corporate earnings. They are determined by the directors of the company’s board.

Note, life insurance dividends also represent earnings but the mutual life insurance companies are required to share all of their company’s profit with the participating policy holders. The profits, in this way, are set for legacy benefits and operating funds. They will be distributed back to the policy holders in terms of dividends.

In comparison to the stock dividends, most people tend to reinvest their stock dividends. If the stock prices are decreasing just after the reinvestment, you are considered going to lose your dividends. Optionally, you should wait for the stock prices to increase so you can recover your dividends. However, if you take your dividends in cash, you won’t lose it.

The Meaning of Declared Dividend Interest Rate

Annual dividends announcement is usually shared along with the interest rate announcement. This implies that the dividends are as the “Gross” interest rate. This way, the actual and distributed dividends are reduced by the three expense areas that are the mortality cost, commissions and the expenses of operating the mutual company.

While it is not necessarily helpful to have ‘gross dividends rates’ comparison, the gross rate just means nothing to the individual policy holders. The only thing to concern is the net rate and the software used to identify the next rate.

For example, a mutual company has 5.9% dividends in 2019. Well, it was just fun. But it would be more meaningful to think of how much cash value will grow this year. Then, it is know that the cash value is growing at an average of 3.9% this year. In the other words, the gross dividend is reduced by 2% costs when your pocket reaches the policy.

However, you should not care too much what the interest rate mean as money that grows by dollar figure is much more meaningful.

Based on the calculation above, you may be able to interpolate the interest rate and check out the guaranteed cash value having the gross rate at 4% along with the net rate which is about 2%. This way, the dividends is added to the guaranteed amount for the whole 5.0% gross and 3.9% net as we have mentioned earlier.

The Common Options of Dividends Life Insurance

As a part of understanding “are life insurance dividends taxable?”, everyone needs also to know the common options of dividends life insurance. In this regard, there are wide range of options but we summarized only a few that is mostly usable. Consider them as follows:

Purchase “Paid-Up Additions”

Paid-Up Additions or PUAs means and additional “prepaid” insurance that generates cash values, grows tax deferred, earns dividends and increases the death benefit. Purchasing PUAs is considered the best way to reinvest into the policy. PUAs is the most popular choice among the life insurance dividends.

Cash / Check

Cash or check is frequently requested by a policyholder to the insurer for the dividends amount. In this case, the policy holder can use the policy to create an annual income. As a result, the dividends will be paid annually on the anniversary date of the policy.

Premium Reductions

To offset the cost, it is common that a policy holder expects that the dividends are saved as the future premium. This way, the annual dividends will be used as the premium on the policy anniversary. However, the premium payments can be completely eliminated by the dividends.

Policy Loan Reductions

With policy loan reductions, the dividends contribute to pay off the policy loan and reducing as well as removing the necessity for cash-out-of-pocket.

Interest Accumulation

Perhaps, the annual dividends can be saved by the insurer to earn interest. This acts as a savings account. The interest earned is taxable to the policy owner each year. With this dividends life insurance option, you will be able to withdraw money without troubling your policy’s life insurance. The money can accumulate, making it payable regarding to face the amount of the whole life policy as a death benefit.

What Are The Recommended Options?

Now that you have already known the option of dividends life insurance, you may be asking which options you are recommended to take. In most cases, PUAs is highly recommended during the early stages of your policy. Then, take the dividends in cash in the later years. This will maximize not only the policy growth but also the income gained from the policy.

If you have already had remaining policy loans or cash flow problems, it would make more sense to apply for the dividends toward the premium or loans.

Are Dividends Just A Return of Overpaid Premium?

Looking back at the definition of dividends we mentioned earlier that it is a portion of the premium’s returns that are paid to your policy, now you may ask; are dividends just a return of overpaid premium?

Basically, dividends are technically referred to a return of premium. However, they won’t work that way in reality. Paying dividends overtime will help significantly exceed the total amount of premium paid. Therefore, it is accurately stated that dividends represent the company’s profit. In short, dividends must be paid when the company offers more profit. This is regarded as one of the guarantees of whole life insurance. However, there is almost an uncertain profit because life insurance companies are managed conventionally.

Are Life Insurance Dividends Taxable?

Are life insurance dividends taxable? This is the main thing that we are essentially underlining since it is our main topic. As you have known what actually dividends are and how they work as well as their common options, now let’s find out whether the life insurance dividends are taxable or not.

Fortunately, the IRS defines the dividends as a premium’s return paid to your policies, therefore, they are NOT TAXABLE. Nevertheless, you should be aware that if you would like to take the dividends in cash, you will owe the taxes on the paid-over dividends. The taxes will be higher than the amount of premium paid.

Again, the dividends which are re-invested as PUAs are NOT TAXABLE. Oppositely, cash dividends from public companies in the tax market out there are taxable.

Are Life Insurance Dividends Guaranteed?

Are life insurance dividends guaranteed? This is another question that you might be asking just after knowing that the life insurance dividends are not taxable. The answer to this question will lead you to create confidence in the asset’s stability.

The exact answer is; the whole life insurance dividends are NOT GUARANTEED. However, dividends are paid by the mutual companies annually for more than 150 years even throughout The Civil War, World War 1, The Influenza Epidemic, The Great Depression, World War II, The Dot Com Crash, The Savings and Loan Crisis and The Subprime Mortgage Crisis and Great Recession.

Using Dividends for More Whole Life Benefits

If you use dividend options to reduce the future premium, purchase PUAs or to purchase any additional term of life insurance, the next taxable result is a wash. Your cost basis will neither be reduced nor increased.

For example, when you use the dividend options to purchase PUAs, you will likely receive a refund of the previous premium you have paid but you can surely add the refund back to your policy through PUAs. Remember, it is not a taxable event.

Withdrawing Dividends From A Whole Life Policy

When you withdraw dividends from a whole life policy through the PUAs, the withdrawal will be taken from your cost basis. The withdrawal is non-taxable as it is assumed that the cost basis is larger than the withdrawal itself.

If the withdrawal is more from the whole life policy than you paid in premiums to the whole life policy, you will have to owe an ordinary income taxes on your withdrawal.

Conclusion

Are life insurance dividends taxable? Based on our review above, the life insurance dividends are not taxable. Even the whole life insurance dividends are not taxable either. As dividends are technically a premium’s returns that are paid to your policy, the more you have them, the more you will have opportunity to earn. You can either save the dividends or take it in cash. To avoid the risk of losing dividends, you had batter take it in cash.